Short-Selling: What You Need to Know Now

On Sept. 18, the Securities and Exchange Commission (SEC) said its ban on the short-selling of hundreds of financial companies would end today, Oct. 2, but could be extended.

It was.

Yesterday, the SEC extended the ban until the third business day after the enactment of the current financial "bailout/rescue" plan before Congress.

Here are a few takes from TheStreet.com on what you need to know about short-selling -- now.

From Jim Cramer's 'Stop Trading!': Thumbs Up to the Uptick Rule:

NYSE head Duncan Niederauer said today that the SEC is considering reinstating the uptick rule. "That would be fabulous," Cramer said. "I hope they don't just do a penny uptick, maybe a nickel or a dime."

Read the full version of Jim Cramer's 'Stop Trading!': Thumbs Up to the Uptick Rule.

TheStreet.com Rewind: The Uptick Rule

Cramer: Uptick Rule Can Help Prevent Crashes (Video, Apr. 7)

Without the uptick rule to slow things down, it is much easier than ever to take a stock and crush it, says Jim Cramer.

To watch the video, click the player below:

Plus, don't miss these related "Wall Street Confidential" videos on TheStreet.com TV: Cramer: Why We Need the Uptick Rule (Apr. 1: The SEC got rid of the uptick rule last summer. That was a big mistake, says Cramer. Legal raiding is important for short-sellers.) and Cramer: Reinstate the Uptick Rule (Mar. 28: Cramer says reintroducing the short-selling uptick rule would help stabilize the banking sector.).

From Cramer: Short-Seller's Paradise:

Nothing from Congress is going to make this market go up. We need the market go up because it is cheap and it attracts buyers, and because there are companies out there that are worth more than they are trading at -- perhaps as private companies, perhaps as investments right now, if anyone had cash and confidence.

Right now it seems there is neither. All we have are the futures, on stocks and on oil, and they bounce around and we do what they tell us at the start. Then the hedge funds come in and start selling because of their broken models and their redemptions. Then the short-sellers come in and figure out ways to knock down things. Then the rumors start about another bank failure and then we go down.

I want to break that spiral because I own stocks. If I am short stocks, I love the spiral.

Now, the bill in Congress does not break the spiral by any means. What breaks the spiral is a sense that the system is not falling apart, which it most certainly is.

Read the full version of Cramer: Short-Seller's Paradise.

From Kass: 11 Ways to Fix the Short Ban:

1. First and foremost, reinstate the uptick rule. This is so fundamental and so obvious it is almost beyond my comprehension why a revision of this rule was not considered first and before the other recommendations were instituted.

2. A timeout on short selling of financial stocks and a brief cooling off period are reasonable, but it should have been focused only on our major financial institutions as contrasted to a broad sweeping policy and commentary that has essentially vilified short-selling. When a General Motors ( GM) is added to the SEC ban on short selling because it has a bank stuffed in it, the ban is preposterous. No doubt, if markets continue their descent, companies with captive financing arms -- that is, nearly every manufacturer and retailer -- will request to be exempt from short selling.

Read the full version of Kass: 11 Ways to Fix the Short Ban.

Plus, don't miss:

  • Kass: Free Market Fraudsters
  • Kass: Blame the Blamers
  • From What to Short When You Can't Short Financials:

    The issue we want to discuss for a moment is the "collateral damage" to businesses because of these financial companies' failure and continued problems. It takes technology to run these large-transaction and heavily regulated businesses. Now that so many are no longer around and the rest are seeing business shrink, what happens to the technology companies providing these firms with their technological infrastructure? These are big contracts that are disappearing, and with existing clients falling like flies, the possibility of growth or up-selling these customers has also become impossible.

    In fact, a large percentage of revenue for technology companies as a whole comes from the financial sector. The financial sector is the largest buyer of tech goods and services. One tech sector that is heavily impacted by these changes is the outsourced technical firms located in India. With financial companies not spending at the same levels and further planned cutbacks, these companies are taking a major hit to their business.

    Read the full version of What to Short When You Can't Short Financials.

    Chris Cox's Short-Selling Ban Stinks (Video, Sept. 18)

    Debra Borchardt says the short-selling ban on 799 financial stocks sets a dangerous precedent and could lead to future disastrous restrictions.

    To watch the video, click the player below:

    From Naked-Shorts Ban Gets Chilly Reception:

    "It's very hard to manipulate in the current environment because, first, we know we're being observed," says Vivienne Hsu, senior portfolio manager of the Schwab Hedged Equity Fund. "And, second, the market would squeeze out those types of buyers."

    Mark Coffelt, president and chief investment officer of Empiric Funds, which has both long and short positions, was also unfazed by the changes.

    "Essentially what they're saying is, 'We're going to enforce the rules,'" says Coffelt.

    Read the full version of Naked-Shorts Ban Gets Chilly Reception

    TheStreet.com Reload: Short-Selling

    In July, the SEC said it planned to crack down on the naked short-selling of Fannie Mae ( FNM) and Freddie Mac ( FRE) and reportedly subpoenaed Goldman Sachs ( GS) and other top banks and hedge funds in its probe into the rumor mongering that has hammered Wall Street's biggest banks during the credit crunch.

    Plus, U.S. Rep. Gary Ackerman (D., N.Y.) introduced legislation to reinstate the uptick rule, which required short-sale transactions to be made at a price higher than the previous trade. The SEC abolished the rule, which had been in place since 1938, last year.

    Now, how much do you really know about "naked" short-selling, the "uptick rule" and short-selling, in general?

    The following are key insights and core lessons from TheStreet.com.

    Cramer: Uptick Rule Can Help Prevent Crashes (Video, Apr. 7)

    Without the uptick rule to slow things down, it is much easier than ever to take a stock and crush it, says Jim Cramer.

    To watch the video, click the player below:

    Plus, don't miss these related videos on TheStreet.com TV: Cramer: Why We Need the Uptick Rule (Apr. 1: The SEC got rid of the uptick rule last summer. That was a big mistake, says Cramer. Legal raiding is important for short-sellers.) and Cramer: Reinstate the Uptick Rule (Mar. 28: Cramer says reintroducing the short-selling uptick rule would help stabilize the banking sector.).

    From Ask TheStreet: Naked Shorts:

    What is "naked" shorting? And why is it so difficult to prove?

    There are strict rules when it comes to shorting stocks, however. One way they are broken is via naked shorting.

    Regulators have no problem with conventional short-sellers if the practice is done according to the rules. In fact, regulators are among the first to say that short selling provides a necessary check-and-balance on the market. Short-sellers, for instance, are particularly good at smoking out companies that are either engaged in fraud or misleading investors.

    It's naked shorting, a manipulative practice that enables traders to defy the laws of supply and demand, that regulators are trying to stop.

    In a naked short sale, a trader places short bets without actually borrowing the stock first or even determining that any shares are available to borrow. This way, the traders are freed from a key check of the short-sale process -- the need to find willing stock lenders.

    Read the full article.

    From How Short Selling Works:

    Short selling is often looked at as a nefarious aspect of trading and investing. However, it is quite legal, serves a necessary function in the securities markets and can be a valuable tool for an investor -- whether on an individual or professional level.

    Short selling provides investors with the ability to profit from the decline in a stock's price, hedge positions or portfolios, manage taxes and create arbitrage positions. Since short selling is complex and operates outside of the sight of many investors, short selling is highly misunderstood. So in this installment of The Finance Professor, I will offer a primer on short selling by covering the mechanics behind the short selling process, the account requirements and the federal regulations that govern the transaction.

    Read the full article.

    From Three Strategies Every Short Seller Must Know:

    1. The Valuation Short

    To review, fundamental research on a company will typically result in earnings estimates which then translate into a price target. When this is accomplished we can then compare our price target to the current stock price. If the stock is below its price target then we will usually be inclined to buy the stock. However, if the stock is above its price target we might avoid or sell the stock, if we owned it. In some instances, the price target is significantly lower than our price target and the short sale of that security might be in order. For example, say that you value a stock at $40 and it is currently selling at $50. According to your analysis, selling short the stock at $50 will yield a $10 profit if the stock hits your lower price target.

    Read the full article.

    From Three Risks Every Short Seller Must Know

    2. Capital Risk

    Because of the unlimited loss potential associated with short-selling, the Federal Reserve requires these two important conditions:

  • Short-selling must take place in a margin account .
  • The short sale must be collateralized by the short sale proceeds plus 50% of the market value of the short sale. The short sale proceeds are posted as collateral for the "stock borrow." However, the 50% market value must be collateralized by cash or marginable securities.
  • Read the full article.

    From Aggressive Stock-Picking: How to Squeeze the Shorts:

    A heavily shorted stock has the potential to soar on any positive catalyst, because so many investors are placing bets against it. This creates an opportunity for aggressive buying -- in other words, betting against the "shorts" that the stock will experience a short squeeze.

    Read the full article.

    From How Do I Find Short Interest for a Stock?:

    Anyone who takes a short position in a stock is entering an interesting situation: In order to exit the position, he or she has to "cover" or buy back the shares that are being shorted. So if a stock has a very high percentage of its shares being shorted, it means that there are more investors who need to buy shares at some point, whether the stock goes up or down.

    This is interesting because those who have already taken a short position need those who own the stock (or are "long") to sell their shares and push the price lower.

    Read the full article.

    To stay up to date on shorting, don't miss TheStreet.com's Short Selling section.

    This article was written by a staff member of TheStreet.com.

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