Businessmen in shorts getting naked

A Dictionary of Finance

If you’ve wondered what a naked short sale is, here is the long and short of a practice that’s often looked at askance by financial traders: short selling.

Sandeep Dhawan came on A Dictionary of Finance podcast to talk about shorts. He explained how naked short sales work, as well as how covered shorts work, and mentioned that short sales are often seen as somewhat immoral, even though they are legal.

“Shorting should be natural activity,” says Sandeep, who works in the Treasury Department of the European Investment Bank. “There is no law that says assets only go up. Expressing a view, long or short, should be equally legitimate. But for some reason shorting is looked upon askance.”

He gets into the details of how naked short sales work, too, because of the opportunity to take advantage of the time between an agreed transaction and the actual exchange of payments, which can be up to a week.

In a naked short, he says, “I don’t have to give you anything. All I’ve done is entered into a contract that you buy the asset off me at today’s price. In two days, when it drops, for example, I buy it back, and seven days later we settle up the original transaction. I didn’t even need to borrow the security to make good on my settlements.”

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