Thursday, September 18, 2008
britain's FSA bans short selling
short sellers must cover. covering means rallies. their extra buying and selling mean liquidity. it is further an essential function of market makers, who must counterbalance order flow with contrary positions to avoid market risk.
therefore the consequence of banning shorts -- as mish highlights -- is to remove liquidity and increase volatility.
pakistan tried this in late june. by mid-july investors were rioting. britain is not pakistan. but this is not a solution to anything.
the law of unintended consequences is quite possibly going to tear the head off the FSA in coming days.
UPDATE: it further extends to the futures and options markets. madness.
UPDATE: todd harrison on the FSA's bonehead move.
Ironically enough, I had a conversation last night with a hedge fund manager who told me "if they ban short selling entirely, the hedge fund community will be out of business."
My response? "Dude, they can't do that—it would mean the end of the global capital market structure. And even if they were to consider such drastic measures, they wouldn't do it until DJIA 7000."
Blimey, we live in interesting times. While this is industry specific, it moves the needle in a most disturbing direction.
UPDATE: adam warner with more.
Let's say I'm standing in an options crowd on some floor and the order flow is getting longer and longer calls. I am going to want to short some stock against it. How about if I am buying an ETF under parity and want to sell the basket of components as an arb? On a much larger scale, what about CDS sellers?
There are myriad derivative products that will cause someone to get physically short a stock as a hedge. And that as much as anything is why Short Interest always trends up over the course of time. The *real* bearish bettors on a given stock may be physically long the stock in fact. So getting the pitchforks out and congregating outside Hedge Fund XYZ's offices because some SEC report publicized that he's physically short kajillion shares seems a tad counterproductive.
again, the function of a ban on short sales is to kill the liquidity associated with all these modes of trading.