Re Re 1: True, but that's another problem that needs to be tackled - too much leverage on financial markets (hedge funds, derivatives)Re Re 1.1 1.2: We can't have equilibrium with naked short selling. I can't even figure it out if prices will ever go to equilibrium after so much naked short selling on Sep/Oct 08 since the stock price path has been distorted.I agree that too much leverage whether on bubbles or busts also need to be addressed fast. For example, the amount outstanding of derivatives needs to be controlled. Hedge funds must be closely regulated.Analysts and famous speculators that put big headlines in the media must be aware of what they're doing. Some regulation is also needed here.Any attempt of market manipulation (upside or downside) should be punished.

QuoteOriginally posted by: Traden4AlphaQuoteMy point is that liquidity is largely an illusion. What people fail to appreciate is that ALL held-for-sale assets carry an implicit short call option in addition to the asset (i.e., a covered call). The short call leg exists because the asset holder grants the market the right, but not the obligation for someone in the market to buy that asset. Because the asset is offered freely, the premium collected on the call is zero (aside from miniscule pay-for-liquidity schemes by some exchanges). The nature of covered calls is that the holder of the asset + short-call is asymmetrically exposed to the downside (i.e., the risk that liquidity will disappear and no one with buy the asset). Thus, all held-for-sale assets are worth less than their mark-to-market values (this discount is monotonic in volatility, holding duration, and vol-of-vol). Needless to say, for long-lived assets in a high vol and vol-of-vol environment, held-for-sale assets are worth much much less than the market price.T4A, I am not sure if I got your point right. Covered call implies downside exposure with no upside potential. But, held for sale assets have upside potential. So, the premium collected on your short "call" is zero bcs of that preserved potential. Am I missing something? Thanks.

QuoteOriginally posted by: AlanFordQuoteOriginally posted by: Traden4AlphaQuoteMy point is that liquidity is largely an illusion. What people fail to appreciate is that ALL held-for-sale assets carry an implicit short call option in addition to the asset (i.e., a covered call). The short call leg exists because the asset holder grants the market the right, but not the obligation for someone in the market to buy that asset. Because the asset is offered freely, the premium collected on the call is zero (aside from miniscule pay-for-liquidity schemes by some exchanges). The nature of covered calls is that the holder of the asset + short-call is asymmetrically exposed to the downside (i.e., the risk that liquidity will disappear and no one with buy the asset). Thus, all held-for-sale assets are worth less than their mark-to-market values (this discount is monotonic in volatility, holding duration, and vol-of-vol). Needless to say, for long-lived assets in a high vol and vol-of-vol environment, held-for-sale assets are worth much much less than the market price.T4A, I am not sure if I got your point right. Covered call implies downside exposure with no upside potential. But, held for sale assets have upside potential. So, the premium collected on your short "call" is zero bcs of that preserved potential. Am I missing something? Thanks.If the market is sufficiently liquid that a mark-to-market value exists, then a "held-for-sale" asset valued at market will be sold immediately. Otherwise it must be valued higher than market value and T4A's virtual call will also be valued higher. In general, if someone values an asset they hold at higher than market value, then all arbitrage arguments regarding the value of that asset and related derivatives imply that the holder's valuation of a derivative will also differ from the market's. In fact, a person who values an asset over market has already stated that they don't respect the arbitrage theorem in the sense that either they've got something wrong or the market has.To put it another way. If they value the asset more than the market, then why don't they buy more of them?The asset-holder may be correct that the market undervalues their asset, but someone reading their accounts who thinks market values and the arbitrage theorem are significant needs to know how much extra value the asset-holder gives to the asset.

QuoteOriginally posted by: AlanFordQuoteOriginally posted by: Traden4AlphaQuoteMy point is that liquidity is largely an illusion. What people fail to appreciate is that ALL held-for-sale assets carry an implicit short call option in addition to the asset (i.e., a covered call). The short call leg exists because the asset holder grants the market the right, but not the obligation for someone in the market to buy that asset. Because the asset is offered freely, the premium collected on the call is zero (aside from miniscule pay-for-liquidity schemes by some exchanges). The nature of covered calls is that the holder of the asset + short-call is asymmetrically exposed to the downside (i.e., the risk that liquidity will disappear and no one with buy the asset). Thus, all held-for-sale assets are worth less than their mark-to-market values (this discount is monotonic in volatility, holding duration, and vol-of-vol). Needless to say, for long-lived assets in a high vol and vol-of-vol environment, held-for-sale assets are worth much much less than the market price.T4A, I am not sure if I got your point right. Covered call implies downside exposure with no upside potential. But, held for sale assets have upside potential. So, the premium collected on your short "call" is zero bcs of that preserved potential. Am I missing something? Thanks.Fermion's point echos mine and adds the important insight that a seller with a higher-than market price on an asset is making a de facto assumption that the market is wrong.What I meant is that when someone offers an asset for sale at price X, they create a covered call with a strike of X. The seller has given the market the right, but not the obligation to buy the asset at price X. The market is free to exercise that call option and will do so if they think the value of the asset has exceeded X. That is, the seller is long the asset and short a call with an exercise of X.Clearly, the seller can withdraw the offer of X (remove the call leg) and replace it with an offer to sell at Y as they see fit. The seller received a zero premium for giving the call option and pays a zero premium for undoing the call option (liquidity payments/charges aside). But the seller's instantaneous upside is bounded by X (or Y or whatever offer price) because that's the price that will trigger a buy. On the other hand, the seller remains fully exposed to the downside because they hold the asset and have no guarantee that anyone will take the offer. My point is to try to provide some framework for the optionality inherent in the offer-for-sale and the fact that seller has no guarantee of a sale unless they give away the upside to the buyer.

liquid HFS assets are always marked to market, they should never be marked to model. no auditor would allow it.

QuoteOriginally posted by: jawabeanliquid HFS assets are always marked to market, they should never be marked to model. no auditor would allow it.True, but I if there's evidence of huge chunks of naked short selling then the market price cannot be fair, at least for a while... It's market manipulation - It creates phantom shares that dillute the value of the firm. I think on naked short selling as the reverse coin of low volume illiquid assets.Regarding the argument: "if they think the market is wrong, buy more"...My example: I think the market is wrong and I bought what I could but I am not willing to buy anything extra due to my budget/capital constraint. The same can be argued for firms.If there's no evidence of price manipulation and the market is liquid then one should always mark-to-market.

QuoteOriginally posted by: BullBearTrue, but I if there's evidence of huge chunks of naked short selling then the market price cannot be fair, at least for a while... It's market manipulation - It creates phantom shares that dillute the value of the firm. can there be sustained market manipulation? i mean for long periods of time. and what would be the reasonable evidence?i thought that PCAOB type of entities would investigate such situation. so if you claim in the financial report that there's market manipulation, you probably have to prove it somehow.i'm thinking about commodities prices. one could possibly claim that there was some manipulation past 2 years in petroleum markets. would this be a reason not to mark to market commodities and related securities? there certainly was market manipulation in energy markets in Enron times, so it's not an unreasonable argument. however, i wonder what's the scope of its applicability.

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QuoteOriginally posted by: jawabeanQuoteOriginally posted by: BullBearTrue, but I if there's evidence of huge chunks of naked short selling then the market price cannot be fair, at least for a while... It's market manipulation - It creates phantom shares that dillute the value of the firm. can there be sustained market manipulation? i mean for long periods of time. and what would be the reasonable evidence?i thought that PCAOB type of entities would investigate such situation. so if you claim in the financial report that there's market manipulation, you probably have to prove it somehow.i'm thinking about commodities prices. one could possibly claim that there was some manipulation past 2 years in petroleum markets. would this be a reason not to mark to market commodities and related securities? there certainly was market manipulation in energy markets in Enron times, so it's not an unreasonable argument. however, i wonder what's the scope of its applicability.Enforcing the Regulator to count the number of shares floating. The best way to start is to check firms with high levels of short ratios as a % of floating shares.I mean, this issue should be inexhistent. I agree that the solution for this shouldn't be done by the "Accounts". We need to tackle the naked short selling problem through criminal investigations. But since regulators failed on this and I think there's enough evidence that US financials were heavily shorted (naked) last year it would be possible to do it. Anyway, I would rather prefer to avoid this situation in the future (through better controls and criminal investigations) and keep booking stocks at market price.

PCAOB monitors the traders constantly. they issue warnings to traders if something's irregular, they see the trades. we don't see it, because mostly it's done off the court. they usually simply call a trader. rarely it goes to the court, traders prefer to settle. my point's that for a company to prove that there was a market manipulation is almost impossible technically, or very difficult/expensive while the regulators are already watching the markets. it surely happens but how do you prove it?

QuoteOriginally posted by: jawabeanPCAOB monitors the traders constantly. they issue warnings to traders if something's irregular, they see the trades. we don't see it, because mostly it's done off the court. they usually simply call a trader. rarely it goes to the court, traders prefer to settle. my point's that for a company to prove that there was a market manipulation is almost impossible technically, or very difficult/expensive while the regulators are already watching the markets. it surely happens but how do you prove it?I guess the end of naked short selling depends on the Regulator's will.A firm can put their lawyers to work and start a law suit against (unknown) naked short sellers and Regulators asking for a criminal investigation. There's evidence of huge short ratios on financials last year - this alone can constitute a first step to ask for a criminal investigation. When there's a crime and we don't know who did it or how it happened the Fed's investigate it. Why not doing it with market manipulations?I'm not an expert in clearing and on how to control the number of shares floating but I think there's an entity able to investigate this - DTCC. Check this link - the letter from R. Shapiro [It's very explicit]Naked-short-selling-Letters-to-the-editor-DTCC-and-RJ-ShapiroI hope these comments from R. Shapiro can elucidate the problem with naked short selling and how it could be solved.

The more I think about it, less concerned I become about naked shorting.In fact, naked shorting creates LESS vested interest in the stock's decline than does regular shorting. With regular shorting, the number of long-holders stays constant, but the number of short-holders grows. With naked shorting, both long and short sides grow equally. In many ways, naked shorting is no different than what occurs in the futures market. Naked shorters merely create more open interest in the stock with equal numbers of people "for" and "against" price appreciation of the instrument.

QuoteOriginally posted by: Traden4AlphaThe more I think about it, less concerned I become about naked shorting.In fact, naked shorting creates LESS vested interest in the stock's decline than does regular shorting. With regular shorting, the number of long-holders stays constant, but the number of short-holders grows. With naked shorting, both long and short sides grow equally. In many ways, naked shorting is no different than what occurs in the futures market. Naked shorters merely create more open interest in the stock with equal numbers of people "for" and "against" price appreciation of the instrument.Yes, the stock market is net long, of course -- and it must be for obvious reasons. Companies sell shares in order to raise capital for risky ventures. Those who provide that capital demand a risk premium. If naked short selling were permitted to destroy that risk premium there would be no reason to provide the capital that a business needs. Speculation would be the only reason for someone without an interest in a company to trade stocks. Those unwilling to speculate wildly (the majority of less sophisticated investors) would stay out of the market in droves.Futures markets exist for different reasons (hedging risk).

I agree with Fermion.It's obvious that the supply of stocks must equal the number of shares issued by the firm. Although most speculators behave that way, in its deep essence, the stock market is not a gambling casino. It exhists for firms to raise equity.If a firm just wants to issue $1bn it does so! No one has the right to issue shares in the name of the firm. Moreover, by issuing another $1bn of phantom shares without the capital "entering" the firm an automatic dillution (price manipulation) is created.$2bn worth of shares floating of a firm that's just using $1bn automatically dillutes the stock price in 50%, appx, over time.The supply of a stock is fixed and decided by the firm itself.Regarding derivatives its main purpose was meant to be for hedging. Hence, the amount outstanding of any derivative should be capped at a small % of the collateral. Otherwise, we might have the collateral "following" the derivative instead of the reverse (I mean in terms of supply/demand and lead-lag relationship). Or we can get to the absurd of the amount outstanding in the CDS market where everybody's trading a "virtual paper" with almost no benefit for society if it's done just for speculative purposes (2 way speculative interest). A CDS can be very useful but not with current amount outstanding.