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Strategies & Market Trends : Shorting stocks: Mechanical aspects
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To: Daniel Chisholm who wrote (169)2/22/1999 9:59:00 PM
From: Q.  Read Replies (1) of 172
 
Suppose I want to sell you the Hope diamond, but I don't own it. I could just sign a deal with you to sell it to you, and take your cash. You accept my receipt saying that you own it now. I hope that you don't ever ask me to physically deliver the stone, until I feel like buying the stone from the guy who actually owns it.

That would be a naked short sale, right?

Somebody has to keep track of the fact that I need to eventually buy the diamond from its rightful owner so I can deliver it to you. That would be the clearing house, right?

Note that two people think that they own the stone: you and the real owner.

Now suppose that I borrowed the hope diamond, and the clearing house stores it in their vault, and I do the same trade with you. The clearing house still has to keep track of the fact that I should deliver the stone to you if you ever demand the physical thing. They have the stone (which they borrowed) in their vault, but otherwise it's just the same as before. And the same two people think that they own the stone.

That would be like a short sale of the normal variety, where you borrowed the stock, isn't it?

If my understanding of this is correct, the clearing house doesn't do anything differently for a naked short sale except that they don't bother to borrow the shares.

I'm just trying to figure this out, and I might be all wrong.
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