The tale of Gamestop

The question to ask yourself is how could there be more than 100% of anything? How could there be 140% of a share float? The answer is simple; the balance over 100%, or

40% are phantom shares. They’re not real shares. They are shares created by naked short selling.

What in the world is “naked short telling?” According to Investopedia, “naked shorting takes place when investors sell shorts associated with shares that they do not possess and have not confirmed their ability to possess. If the trade associated with the short needs to take place to fulfill the obligations of the position, then the trade may fail to complete within the required clearing time because the seller does not actually have access to the shares.”

The technique is known to be very high-risk level. However, the potential to yield high rewards makes it more desirable.

Years ago, before everything was on the computer, messengers would take around stock certificates, ‘pieces of paper,’ from one broker to another. However, when computer transfers became predominant, there was no need for physical certificates anymore as everything became digital. Although people still retain the right to ask for paper, most do not.

When there were paper certificates, people needed time for settlement. The physical certificates had to move from one place to another. There were a lot of written instructions. The settlement took three days at least which has since been reduced to two.

After the financial crisis in 2008, the Securities and Exchange Commission (SEC) banned the practice of naked short selling in the United States. That said, it is worth noting that the ban applies to naked shorting only and not to other short-selling activities.

Investopedia reports that before this ban, the SEC amended Regulation SHO to limit naked shorting possibilities by removing loopholes that existed

for some brokers and dealers in 2007.

Regulation SHO requires lists to be published that track stocks with unusually high trends in failing to deliver (FTD) shares.

If all of the above sounds a bit foreign, let’s connect the dots by first defining a short sale. Let’s say you expect “Company A,” currently trading at

$50/share to fall to $40, and you have the capability to short this stock, in this case, “John.”

Theoretically, John will identify the owner of the shares of Company A which will loan them to John at a percentage of interest, commissions inclusive. John plans to sell the stock at $50, wait a while and purchase them at $40, with a profit of $10 on each share. This is exactly the opposite of what the average investor intends which is to buy a stock and then hopefully sell it

later at a higher price.

Note that John doesn’t keep the $10 entirely as there are interest and commissions to be paid, but ultimately, there’s a lot of profit to be made by all, except the company whose stock just got shorted.

Now, the news has gotten around that the shares of Company A are expected to drop and is being shorted. Another individual, “Bill,” is also interested in shorting the shares. However,

Bill doesn’t have them so he contacts his broker who, without having the shares

in his/her possession, nonetheless performs the transaction for Bill.

This is naked shorting. No imagine that this cycles through hundreds of investors involving millions of dollars.

Naked shorting has the potential to bankrupt a company as more shares are being transacted than can be delivered/settled. Sadly, these are often small start-up companies or companies already fighting for mere survival.

Some Reddit users noticed this trend with

GameStop shares and went for a kill; they noticed how badly GameStop shares were being naked shortened and rather than sell bought in, which drove the price through the roofs only to have it come crashing back down as those shorts were eventually covered.

Please note that all data is for general information purposes only and not meant as specific recommendations. The opinions of the authors are not a recommendation to buy or sell the stock, bond market

or any security contained therein. Securities contain risks and fluctuations in principal will occur. Please research any investment thoroughly prior to committing money or consult with your financial advisor. Please note that Fagan Associates, Inc. or related persons buy or sell for itself securities that it also recommends to clients. Consult with your financial advisor prior to making any changes to your portfolio. To contact Fagan Associates, Please call (518) 279-1044.