Quick Update And Preview

I spent most of today researching and working on some graphics for my next big article (should be interesting). I also spent time meeting and talking about investing in Russian Agriculture (update on this tomorrow too).

Here is a preview of some of the graphics for tomorrow's entry:




UPDATED: May 08, 2009 9:25 PM

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5 Responses to Quick Update And Preview

  1. Robert says:

    Eric,

    Nice diagrams. A couple of things..

    In the "normal short selling" diagram, 2 "the securities lender" includes many the broker's own customer accounts.

    In the "naked short selling" diagram, you've labeled the outbound arrow "IOU" but actually the trades that are posted to the "market" are always IOUs.. settlement takes place (or not) through another process. So really the arrow in the normal short selling diagram should also say "IOU".

    I think having a big block called "the market" may also confuse the issue since the broker dealer is always broking deals between two known parties (one of which may of course be another broker dealer acting on behalf of their own clients). The point is that many of these parties will already have relationships with the broker and so their securities may be immediately available for lending again as soon as they are "delivered".

  2. Robert said...
    In the "normal short selling" diagram, 2 "the securities lender" includes many the broker's own customer accounts.

    Yes, it does (all securities in margin accounts are availble to lending). I plan on mentioning this in my entry tomorrow.

    In the "naked short selling" diagram, you've labeled the outbound arrow "IOU" but actually the trades that are posted to the "market" are always IOUs.

    The graphics above are focused exclusively on the settlement part of (naked) short selling. In a normal short sale, an actual share (borrowed from a securities lender) is delivered to buyer. In a naked short sale, a "share entitlement" is delivered to buyer.

    settlement takes place (or not) through another process. So really the arrow in the normal short selling diagram should also say "IOU".

    Again, these are graphs of the settlement part of (naked) short selling. I assumed it would be understood, but I will make sure emphasize this in my article tomorrow. After all, whether a short sale is naked or not depends on what happens during the settlement of a trade: the "failure to deliver" of a share during settlement (because it was never borrowed) is what makes a short sale "naked".

  3. Robert says:

    Hi Eric,

    If what you want to illustrate is failures to deliver then the IOU arrow should be "delivery failure" or something like that.

    I am not entirely sure that delivery failures are what most people think of as naked short selling (although they are certainly related problems).

    The short selling regulations only require brokers to "locate" shares anyway - they don't actually need to borrow them in order to be legit.

    Also, settlement is always netted between counter parties so there is not always a need to actually settle some particular contracts.

  4. Robert says:

    Another thought;

    The net settlement transactions part is actually pretty important.

    Say you have a bunch of trades that go through on day 1 for settlement in 3 days (T-3);

    The important thing here is that all the trades done on the same day (T) are netted together during settlement.

    That means you can short in the morning, buy everything back in the afternoon and due to net settlement there is no settlement obligation in 3 days time.

  5. Robert said...
    If what you want to illustrate is failures to deliver then the IOU arrow should be "delivery failure" or something like that.

    A delivery failure creates a "share entitlement" (an official stock IOU).

    The short selling regulations only require brokers to "locate" shares anyway - they don't actually need to borrow them in order to be legit.

    True, but that is to be expected. It is very normal for the small lag (key word here is "small") between when something is paid for and when it is delivered. If you order a book on Amazon.com, it is ok for it to arrive a week later. However, if you order a book on Amazon.com and it arrives a year later, there is a problem.

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