You think Widget company is over valued at $25 per share and will soon be trading at $15. You sell/short 1000 shares of the stock at $25 which gives you $25,000 dollars. If you are right, when the stock falls to $15 you will buy 1000 shares and repay the shares you borrowed. You will keep $10,000 as your profit.
At this point you are in a naked short position because if the stock does not fall, then your potential losses are unlimited as the stock climbs ever higher. This is a very dangerous and stupid position.
But, if at the same time as you short/sell the stock at $25 you buy long call contracts at $25, you limit your potential loss at $0.00
Gain if you are right $10,000. Loss if you are wrong $0.00 Good hedge, you're covered and can't loose more than the price of the long calls.
Many of you will not understand the terms used or how these investment products work. But the so-called hedge fund who is screaming they are losing billions has only their own greed to blame. Frankly in my opinion they should go out of business, they are too stupid to play with the big kids.
Technically the position you described is just a short. A naked short occurs when the stock you borrowed isn't absolutely certain to actually exist. This can occur when there are a lot of transactions, and they aren't clearing and reconciling fast enough. In that situation, the Hedge fund is actually selling a stock they don't own by borrowing it someone who doesn't own it either. Naked shorting is illegal, but as we know, the people who do it aren't subject to laws like the rest of us.
Thanks for the description.
Now can you explain to the folks whether buying XYZ stock on the open market puts any money in XYZ's pocket?
And typically the companies founders are holding a large number of shares, so they benefit when the stock price rises.
Only at the initial public offering (IPO) do any of the funds flow to the company. Any trades after the IPO is putting money in the hands of the people who hold the stock.
Of course the company can, and frequently does hold back stock during the IPO and sell that stock into the market later.