Gary, I would put it in a slightly different way.
- Shorting is a lending transaction that creates a mark-to-market financial liability for the seller (Short).
- A retail buyer, thru a brokerage, buys a mark-to-market financial asset.
- It is very similar to how banks create “money” through lending. They add liquidity to the system. But they do not change the number of legal shares.
- The system can be abused because it's difficult to reconcile “synthetic” positions against the legal ledger in real-time.
But it shouldn’t matter to Retail Longs. Retail buyers are protected because the brokerage owes them the asset. We aren't buying fake or phantom shares. We are buying a legal claim to shares that the broker must honor.
That is how and why during a short squeeze, the brokerage (acting to protect their own balance sheet from the “other side”) will trigger forced liquidations. Brokerages will not just want to buy shares, they will be forced to, by their own clearinghouse. They will buy NWBO shares on the open market to close out the risk, regardless of the “squeezed” price then. The Short/MM will simply be charged the bill, automatically.
The misconception:
MMs are exempt from margin calls and can hold short positions forever.
Not so:
They have to maintain a “Net Capital” in their account with the NSCC (clearinghouse). If it drains too much, they get margin calls.
How is it drained:
By the forced liquidations of short positions as the price rises.
Said in a simpler way:
Saying market makers don’t get margin calls is like saying a casino doesn’t have a budget. The casino has more leeway than the gamblers (regarding margin calls), but if the house starts losing too much, the regulators and clearinghouse will shut them down to prevent a total collapse. They are not immune; they just have bigger credit limits.
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