Here is a response to that post from a market maker of my acquaintance that I asked to look it over...
Okay, point by point.
As a Professional Trader, I see it every day. In fact, this past week alone, a new candidate hit the list. Eltek(ELTK) posted great quarterly numbers about 10 days ago.
I don't follow ELTK. As a result, all my comments will be about markets in general.
Take a stock that is trading maybe 500K-1mil shares a day. Take the slow time from 11:30am-1:00pm EST. The MM's are kiting shares on an immediate basis. I will enter an order to buy an obscure amount of shares...like 1423 or 2137 shares. I buy them on the ask.
This is an accurate description. In fact, it is what a market maker is SUPPOSED to do. We are supposed to provide liquidity. We are supposed to be there on the offer when there is a lot of demand, and we are supposed to be there on the bid when there's none. We are not supposed to lose money, but we ARE supposed to take a calculated risk to provide liquidity. If a market maker blatantly avoids doing this, then he is theoretically subject to NASD sanctions.
All market maker sales are naked. If I'm a market maker in a heavily traded stock (and we are in two of them), all our sales are naked unless we happen to have the stock in inventory. In the case of one of these stocks, we do happen to have a multi-million dollar inventory, but that is rare. In any event, if there is no inventory then all sales will be naked. In the case of a stock where we have no inventory, yes, the sales will be naked. Now you can easily borrow millions of shares of that stock (the float is over a billion shares with about 100 mil short), but that's not the way market making works. Getting locates takes time and thus would impede what we are supposed to be doing. Last month we bought and sold 7 million shares of this stock. That's what we are supposed to be doing--and presumably the market benefits from the liquidity.
We don't happen to be a market maker in MSFT, but I can assure you that all the market maker sales for their own account are naked. That's right--tens of billions of shares, hundreds of billions of dollars. This doesn't seem to bother Bill Gates. But it does bother the traders and owners of crappy, little companies.
As I said, the MMs will kite those shares that were sold to me and sell them again. Just watch the tape. Sure enough, a few minutes later at the ask or a penny or two above the ask, here comes the identical same number of shares crossing the tape.
Huh? How do you get those prints above the ask? In particular, how can I get some of those because I really, really WANT them? It would not be surprising to see the same odd number of shares come across, but they would not be above the ask--they would come at some other price, probably on the bid--as the market maker tries to flatten the position or at least to get a round number of shares. No one is magically selling the SAME shares. We don't have to; we we can short without a borrow, so why short the exact same number of shares again? There's a point to buying-to-cover the exact same number but not to shorting the same number.
Not just in theory, but in provable practice, it takes twice as many shares to make a stock go higher as it does lower.
Why would this be? To put it kindly, this indicates a naivete about the markets.
This is the MAIN reason the MMs are fighting so hard to keep Level 3 out of the hands of the investing public. They scream we should not have access to their complete book. This is so they can hide this illegal practice, and so we can't see their intent to steal the stop-loss shares of so many stocks on their slam campaign.
Malarkey. This is a comment from someone who has never seen a Level 3 display. There is this widespread misconception that we can see other market makers' books and in particular stop-loss orders. This is nonsense. What we CAN do is come into a market maker for a lot more than is displayed. This is not an Auto-Ex order, and the market makers can accept or decline. If they're on the offer, and they take a partial, our order does not automatically show up on the bid, as a retail order would. Since our company's particular style is to seldom hit other market makers, we are usually on the bid or ask. If someone comes into us for a large quantity, then we do get market color in a way that a retail trader would not. A retail trader can mimic this ability to a limited degree with a high-end connection to an ECN, and I've done it trading my personal account. It's not the same, but the distinction in market information is not as profound as one would think at first glance.
I couldn't care less if someone else has Level 3. Periodically I am intimately involved in the details of a particular trade or series of trades. I don't have Level 3 on my machine, nor do I want it. I am quite content to give input to traders without ever seeing Level 3. The retail interest in Level 3 is just an extension of the belief that the big boys have to have some special advantage.
It is true that we will try to utilize retail traders' stop-losses to maximize our profits. WE CAN'T SEE THOSE STOP-LOSS ORDERS. But we have a good idea where they are--from trading experience. What we do can be done just as easily by retail traders.
Four days from now, they will kite shares to replace all the nakeds from today that are settling. Then, they will pass the entire lot off to a hedge for a fee to skirt any FTD's.
Huh? How does passing a position to a hedge fund cure a fail? Why would a hedge fund accept a failing position? Why would they pay you for a failing position? How can I get some of this business?
I have not the slightest doubt that a really good BORROW in a heavily shorted stock would be worth real money. In fact, I'd be willing to pay good money for such a borrow. Actually I already do as an individual. The short interest charge for TZOO until this month was 52%. You read that right. Usury laws do not apply to borrowed stock. I have a wonderful average price in TZOO, and I still probably won't make much money on the short--it all went to the firm lending me the stock.
Back to ELTK:
Since that $6.40 on Monday, CIBC World Markets showed up with "the refreshing ask from hell". CIBC had no previous position in ELTK.
How does this guy know? How do I get market info like this? What's the name of the service and where can I sign up? I'd probably be willing to pay 100k a year for this.
From that point on Monday, the stock traded over 14 million shares and CIBC shorted and/or sold 6.683 million shares.
This info must come from that special service this guy has--the service I'd like to get the name of. Actually, maybe this service isn't so great, because this particular info makes no sense. There is absolutely, positively no way that CIBC went short 6.68 mil shares of a 2.8 mil float stock. WE ARE ALL IN BUSINESS TO MAKE MONEY. Only a manically self-destructive company would do a thing like that. I have personally been short 7% of a company's float, and, believe me, I was on pins and needles the whole time. As market makers and individuals, we are trying to make money, AND WE ARE EXTREMELY SENSITIVE TO THE OVERALL SHORT POSITION. As market makers, we have bid aggressively on stocks where we felt shorts were vulnerable, just as retail traders try to do. If we can do it to other people, then they can do it to us. One of our jobs is to make sure that never happens.
After their earning's release on 3/21, ELTK showed up on 3 German exchanges as a listed company WITHOUT THE COMPANY'S CONSENT.
This is a common, silly ploy. I have never heard of anyone making serious money at it. First, there's not enough volume on the German exchanges in these small issues to make decent money. And, second, the supposed ploy of telling the firm where you have shorted domestically that you have foreign stock to cover the short doesn't work for that long. MAYBE you could get a few days out of it. So what?
But I grant that this ploy is done. There are a lot of stupid things in the market.
Ultimately all fails get cured in time. This fantasy world of never having to deliver is foolishness.
I'm not going to repeat the list of demands this guy has. I saw them before on the Yahoo board. Idiocy.
Finally there are a few overall points I'd make.
First, market makers are not angels. I have seen a fair number of illegal things. Naked shorting is not one of them. Naked shorting is what we are SUPPOSED to be doing in the face of great demand. Naked shorting in the absence of substantial demand--in other words, to kill a stock, would be market manipulation, and this IS illegal. I have never seen it happen.
Most of the illegal activity I've seen has been when a market maker is working in concert with a promoter. The joke in our office is that, if another market maker calls you and begins the conversation with, "Hey, buddy", what follows will not be a legal suggestion. I have yet to see an exception to this rule.
The notion that stocks are being killed by rampant naked shorting is ludicrous except where there is a floorless or near-floorless convertible debenture. In any event, some firms do not even consider this naked shorting anyway. However, floorless or near-floorless convertible debentures are the source of a lot of selling pressure. But even here the shorting has to be timed so that fails and consequent buy-ins don't occur.
A philosophical point: ultimately markets don't require market makers or short-selling. They could exist without them. Market makers and short-sellers do improve markets for INVESTORS, but traders hoping for wild run-ups may not like short-sellers, and traders hoping for short squeezes may not like market makers. On the other hand, if these complainers are so concerned about market makers, I would recommend they confine themselves to gray market or unsolicited stocks. There is hardly any market-making or any short-selling there (there should be none, but I think there are small violations). Of course, on those unsolicited and gray market stocks those massive spreads are sort of a disincentive. Somehow I get the feeling that these complainers want to have their cake and eat it too--they want great liquidity and narrow spreads, but they don't want market makers. Kind of sounds like someone who has not outgrown their desire for the tooth fairy.
