Feb 18, 2021 - Economy

Explaining GameStop hearing terms: Short-selling

Medal ribbon over empty box

Illustration: Aïda Amer/Axios

The reason that GameStop stock rose so sharply last month was, paradoxically, because so many people had bet that it was going down.

Why it matters: That kind of bet — known as short-selling — is often considered distasteful, or worse.

Driving the news: Robinhood CEO Vlad Tenev set the tone for Thursday's hearing by tweeting this week that "it should not be possible to short sell more shares than are out there."

  • The blog post he linked to subsequently had to be edited to admit that "as long as there is short selling, there will always be a chance that short sellers can short more shares than there are outstanding."

Between the lines: Short-selling involves borrowing a share from one person and selling it to someone else. Since both people then own the stock, the process effectively increases the gross number of shares outstanding, while keeping the net number of shares constant (since the person shorting the stock effectively owns -1 shares.)

  • This process is normally harmless, and helps with liquidity and price discovery.
  • Tenev says in his Congressional testimony that Robinhood "does not allow short selling."
  • He doesn't mention that he's happy to facilitate billions of dollars' worth of trades in put options, none of which would be possible without other market participants hedging those options by shorting stocks.

By raising the specter of "naked shorts," and even raising the question of whether short selling should be allowed at all, Tenev perpetuates the fallacy that when a stock has a large short interest of more than the free float, that's evidence of nefarious activity or market manipulation.

The bottom line: Short selling is a time-honored, much maligned, and little understood part of the financial markets. More famous CEOs than Tenev — including Elon Musk — have railed against it, but there's no political consensus to try to curb it.

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