Naked Shorting

The term “naked shorting” refers to the illegal operations regarding short selling shares. Usually these shares have not been determined to exist that is why the practice is called illegal. Typically, traders are obligated to check whether stock can be borrowed before short selling it. It is also relevant to the borrowing stock itself. Thus, "naked shorting" refers to shorting a stock, which can be more than the number of shares traded in the market.

Although naked shorting became illegal after the 2008-2009 financial crisis, it continues to occur because of gaps in the rules and differences between trading systems.

Naked shorting occurs in situations when shareholders sell stocks that they do not possess or have not confirmed the ability of shares to be possessed. The investor does not own or lend the object of speculation, but immediately sells it to a third party. At some point in time - at the latest at the time when the investor has to hand over the object of speculation to the person to whom he has sold it - the investor buys or borrows on the market to settle the trades. 

The difference in price at the time of sale to the third party and at the time of repurchase is the basis of profit or loss. If the price has fallen significantly between the sale and the repurchase, the speculation is profitable; otherwise, the investor will experience a loss. The naked shorting carries high risks but can be extremely profitable for the trader. 

There is no measurement system for naked shortings. However, many of the existing systems point at the failed transactions when trades are not delivered from the seller to the buyer within a certain period of time. Usually most of the failed trades are referred to as naked shortings.

Influence of Naked Shorting

As with the prevalence of "naked shorting," its implications are disputed. The SEC has said that the practice can be useful for increasing liquidity in hard-to-borrow stocks, and others believe it improves the efficiency of the securities lending market. Critics of the practice argue that it is often used to manipulate the market, that it can harm companies, and even that it threatens some of the markets.

Naked Shorting regulations

Naked shorting operations were made illegal in the US after the financial crisis in 2008. The Securities and Exchange Commission (SEC) banned the naked shortings. The ban does not apply to other types of short sales.