As ‘short sellers’ swarm again, SEC will mull restrictions
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‘Short sellers’ sharply boosted their bearish bets on stocks in the first two weeks of this month, a winning trade as blue-chip indexes dived to 12-year lows.
But the jump in short selling also may have helped set the stage for the market’s turnaround since March 9, assuming that some bears have rushed to close out their bets as stocks have rebounded.
The strategy of short selling -- and the question of whether to rein it in -- will be on the agenda when the Securities and Exchange Commission meets on April 8 with new Chairwoman Mary Schapiro at the helm.
The risk of adding to pressure for a regulatory push-back didn’t restrain the bears in the first half of this month: New York Stock Exchange data show that the total number of NYSE shares sold short surged to 16.2 billion as of March 13, a 10.7% jump just from the end of February and the highest total since Sept. 15 -- when the market’s fall meltdown was just beginning.
In a short sale a trader borrows stock from a brokerage or money manager and sells it, usually hoping the market price then will slide. If the bet is correct the trader can buy new shares later at a lower price, repay the loaned stock, and pocket the difference between the sale price and the repurchase price.
Shorting can be a direct bet on falling prices or a strategy to hedge a portfolio in case of a market slide.
Either way, if stocks rise instead of fall short sellers can face unlimited losses until they close out their bets. Such ‘short covering’ can help power market rallies once they get started.
The Standard & Poor’s 500 index has rebounded 20.3% since hitting a 12-year low on March 9. There’s no way to quantify the effect of short-covering, but fast turnarounds often spur some shorts to give up on their trades.
The role of short sellers in driving stocks lower has been a heated topic since last summer, particularly in the case of battered financial shares.
Critics of short sellers want to bring back the so-called uptick rule, which the SEC revoked in 2007. The rule, on the books since 1938, required a short seller to wait for an uptick in a stock’s price before shorting it. The idea was to eliminate the potential for a cascade of short sales that could send a stock into a death spiral.
The SEC gave up on the rule because it said, in effect, that it was antiquated and wasn’t necessary in a modern market. But the horrendous bear market has changed some minds about that.
The SEC on April 8 will consider whether to restore the uptick rule or place other curbs on short sellers. Major securities exchanges this week sent a letter to the SEC suggesting a modified uptick rule, which would kick in only after a stock has fallen by a certain amount, say 10%, over a specified period.
Read the full letter here.
-- Tom Petruno