It sounds like you're struggling to grasp the specific, underlying scenario I'm discussing. Don't feel bad, this is dark and shadowy as it gets on Wall St.
The scenario you describe above is how naked shorting by MMs is
supposed to work, and why an exception allowing it for MMs was made in SEC Regulation SHO.
What I'm talking about is abuse of the short selling exemption, when a MM undertakes to sell a share short on their own behalf, for profit, as part of their proprietary trading. This is specifically NOT allowed under Regulation SHO, but is difficult to detect thus poorly policed, and seldom enforced.
When a MM does a naked short sale for their own benefit, the follow problems occur (among others):
- they receive full payment for the share, yet have zero capital outlay (nobody checks MMs accts)
- there is no 3rd party responsible for the return of the share
- there is only the MMs own capital reserves to back the transaction
- this imples there is huge risk for the low-probability worst-case outcome (MM failure)
- they can literally create as many shares as needed to move the SP to the point they desire (unfettered by the need to locate a share b4 selling, and with ZERO elasticity of demand setting the SPs)
- they often have no need to deliver those shares at all, as long as they succeed in driving down the price within 13 days (when an FTD report would be required) to the point where they can buy to cover
- this creates an tremendous financial incentive to create large short positions, well beyond what the market may indicate is appropriate (wonder why TSLA at 1/10th the size of AAPL has a larger short interest?)
So, I suggest you narrow your focus to the specific problem under test, and redo your analysis. I think you'll find the combination of inherent secrecy and financial gain is a powerful enabler for MM misbehavior.
Cheers!
