John Olagues, the options market-maker who first analyzed the collapse of Bear Stearns and Lehman as the result of a concerted attack, has a new piece at Investopedia criticizing the ¨naked short selling¨critics:
Naked short selling is often in the news today, and is criticized by journalists and other pundits who claim that naked short sellers allied with “rumor mongers” caused the collapse of Bear Stearns and Lehman Brothers. They cite the large “failure to deliver” for a stock as evidence of naked short sales days after the stock had dropped. Although the naked short sales happened after the collapse event, they still hold onto the idea that those after-the-event naked short sales caused the collapses. (To learn more, see Case Study: The Collapse Of Lehman Brothers.)
In my opinion, those who believe that naked short sales caused the collapse of Bear Stearns and Lehman Brothers are misdirecting the attention from the illegal inside traders and their allied manipulators.
The large volumes of “fail to deliver” stock and the naked short sales after the collapses of Bear Stearns and Lehman Brothers leads me to believe there is an explanation for those large volumes. However, that strategy did not cause the collapse of those companies. (For more, check out our Short Selling Tutorial.)
The Bottom Line
Selling short can be done in a myriad of ways. And, although naked short selling is often given a bad reputation in the media because it is frequently abused, it is not as nefarious as its critics suggest.
My Comment:
I´ve gone back and forth about this with Olagues, as well as with the most prominent figure in the naked short-selling campaign, Patrick Byrne…and it occurs to me that a lot of the problem lies in language – as is the case in other areas of political debate too.
Distinguishing between naked shortselling and other forms of shortselling where the shares fail to deliver seems to the source of the problem. NSS should include within it all forms of shortselling that do not cost the seller.
When the seller does not pay the actual price for his transaction, his activity is no longer adding information to the market. There is no price discovery, because the cost of the shortselling has been arbitrarily shifted elsewhere and in fact miscues the market. So what market-makers do in the course of their legitimate activities and also when they´re trying to exploit their position for their own benefit would come under the NSS rubric..
Aside:
I would go on..but I have had computer problems for the past two weeks…the keys type whatever they want to …I cant use the apostrophe, the parentheses have vanished, and when I type a dash, out comes an equals sign….which is why I keep using dots..and there are no contractions.
Dear Lila:
Thanks for the posting. I am by no means a fan of manipulators of stock or those who trade on illegal inside information. I am no fan of those who bought puts in Bear Stearns on non public material inside information, nor of those who shorted stock on inside information (regular way or “naked”).
I don’t support the idea that the “naked short sellers” caused the collapse no more than buyers of calls prior to the announcement of a takeover cause the stock to jump after the announcement.
I lost a good bit of money in the Bear Stearns collapse and from my experience and from that of highly experienced traders, the collapse was manufactured months before and was “pulled” faster than you can say “Larry Silverstein”.
I am puzzeled that Mr Byrne, Taibbi and Vanity Fair, Dimon, Cox, Fuld, Cramer, and Pandit persists in blaming “naked short sellers” as the cause of the collapse of Bear Stearns and Lehman in the face of strong evidence to the contrary.
And its not an over-statement that some of those have credibility problems.
But I guess I had better explain where those “fails to deliver” came from.
In 1983 when I was trading at the CBOE perhaps 3000 contracts per day, which was a lot for one individual in those days. I discovered that some owners of deep in the money puts were not making early exercise as they should. It may have been the case that the owners didn’t understand that when puts get deep in the money they should be exercised early or they may be other reasons.
Nevertheless, I wanted to get my account short those puts and short stock which was approximately delta neutral and I could earn interest with little or no risk.
So I figured out that if I bought a put and sold another put, where they both had sizable open interest and both were in the money to the extent that both puts should be exercised, I could immediately exercise my long puts and I would hope to be short stock and short an equivalent # of puts.
So that was a strategy which I created 25 years ago.
I noticed one day in January 2008 in Citigroup stock that 85% or the options volume was related to market makers doing the above type spreads. That is because the open interest were so large in those puts and the stock had recently dropped considerably, making lots of puts candidates for my strategy.
So if 10,000 put spreads are done as I described by a market maker and he exercised the 10,000 puts but he was only assigned 1/2 of the puts that he sold, he would have a position that was naked short 500,000 shares of stock and short 5,000 deep in the money puts.
The risk was very little as his deltas were about equal. So three days later, there are 500,000 fails and the naked short seller police yell “naked short sale” but “Macavity was not there”.
That is the explanation for the build up of Fails to deliver 4 or 5 days after the collapse of Bear Stearns and Lehman. That is because three days before the fails, market makers were exercising puts to make what interest the could on the short stock positions from the early exercises on puts that were all of a sudden early exercise candidates.
Cheers:
John Olagues
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