“1. What happens if the naked short seller Person B doesn’t have the $ to actually buy the stock to give back to Person A?”
Excellent question, actually.
People who want to short stocks typically have to have reserves of 150%. So a $10 stock requires $15 to be placed in the broker’s account first in order to execute a short sale.
Of course, if the price goes up, and the increase exceeds that 150%, then the broker usually requests more funds to be deposited. If you still cannot meet the price of the stock, you are bankrupt if you cannot cover the costs.
This does happen, and routinely. However, most investors have plenty to cover losses. Let’s say that $10 climbs to $50 *ouch*. An investor usually calculates what they can afford to risk and can probably cover that $50. If that stock climbs to $500 *super ouch*, the investor may not have calculated that risk and could literally be in bankruptcy court.
It is not illegal to be upside down on a short, but like all debt, you can find yourself in collections.
Hmm, I sort of understand. A completely different world; nay, universe, than what I inhabit.