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Summer School: Naked short selling

Financial summer school

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Tess Vigeland: Well, we just went through your notes, so now it's time for you to take some.

Last week, the Securities and Exchange Commission put limits on something called naked short selling. Trust me, it has nothing to do with the altogether.

At the blackboard for today's Marketplace Summer School session is our very own Amy Scott.


Amy Scott: Short selling is basically a way to make money when a stock price falls. Think about a stock as a box of Girl Scout cookies, maybe Thin Mints. So let's say I'm pretty sure the price of Thin Mints is going to go down, so I borrow a few boxes from my neighbor and sell them at today's price. My hope is that when it's time to pay my neighbor back in a few weeks, the price will have dropped and I can buy the Thin Mints at the cheaper price and pocket the difference.

There's nothing illegal about short selling and in fact, many people say it's good for the market. If a stock is overvalued, short sellers can actually drive the price down and that can lead to more accurate stock prices for the rest of us. But recently, short sellers have been blamed for driving down the stock prices of some pretty big financial companies and the Securities and Exchange Commission is investigation whether there was some actual manipulation going on.

To try to prevent market manipulation, they've cracked down on a form of short selling known as naked short selling. Let's go back to our Girl Scout analogy. So let's say I never actually borrowed the Thin Mints from my neighbor, but I sold them anyway. That's known as naked short selling. I may have located some Thin Mints from a friend a few blocks away, but never actually sealed the deal. Then when it was time to deliver the boxes, I couldn't meet my end of the bargain. The reason they call it naked is because I'm left uncovered when the deal is actually supposed to be sealed.

For the average investor, short selling can be a good thing because it sort of keeps stock prices honest, but naked short selling allows stock manipulators to drive the price down artificially, which is why the SEC is cracking down on it.


Vigeland: Amy Scott is our New York bureau chief. Somebody get her a cookie, please! And next week, tune in for tax credit versus tax deduction.

About the author

Amy Scott is Marketplace’s education correspondent covering the K-12 and higher education beats, as well as general business and economic stories.

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