Good post.
One way in which “naked short selling” occurs is that a large hedge fund manager who is short the common stock desperately wants the price to go down. So he will buy for example 1000 put contracts, which is the equivalent of 100,000 shares. The market maker sells him the puts, but does not want the risk associated with being short puts, so at the same time the Market Maker forces the hedge fund manager to buy 100,000 “shares” from his “inventory” — which in fact is nothing more than a ledger entry. The market maker does not have to have stock to sell the stock they are obliged to make a market and they are entitled to sell “naked” in the course of their duty in making the market.
So the hedge fund manager now has 100,000 “shares” which he can sell into the market to either undermine rallies, or ‘pile on’ on down days, or to churn, or to cover without disrupting the intraday market trading.
This is called “renting the market maker exemption” and is used quite a lot once a stock reaches its threshold in terms of the amount of legitimate shares available for borrow.
This is how shorts can get the upper hand especially over mid-cap stocks with modest sized floats. The supply of shares is artificially increased, and the companies targetted for short sellers are the types of companies that don’t get widespread coverage, have high growth, or large investment backing by long funds and institutions. There just aren’t enough interested longs to drive the shorts out.. in fact in a lot of cases the hedge fund has more cash than the entire market cap of the companies they target.
Interesting, I wasn’t aware of that mechanism, at least in such size.
In reality, naked short or no naked short, no single hedge fund player has enough money to "push" the market in any direction for more than a few seconds and that few seconds wont be enough to recoup profits on a big directional position.
This is the kind of thing that high school kids believe drive markets... the back rooms... the secret deals... but none of it exists in reality. It's the fodder of conspiracy theories, but it's all bunk. Oswald acted alone, and none of this bull has an impact on market prices.
Equity being created 'ex nilo', just like a money supply expansion from bank lending.
The issue here is whether this is worse than a legal prohibition spreading more government restrictions into the market. Many argue (falsely) that bank lending always causes inflation. The fact is that deflation can even happen during money creation from bank lending, just like 'naked shorts' can occur with increasing stock prices.