Regulation of credit derivatives

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Credit derivatives and short selling

Short sale

A short sale is a mechanism for profiting from an expected fall in the market price of securities. It takes place when a market participant agrees to sell securities which it does not own. There are essentially two types of short selling: covered and uncovered (also known as ‘naked’).

In a covered short sale, the market participant borrows securities from a holder (lender) in return for a fee, and sells them to a purchaser. The market participant then purchases an equal number of the same securities in the market before the date on which the securities are due to be returned to the lender. If the market price of the securities falls between the date of the sale to a purchaser and the date of purchase of an equal number of securities in the market, the market participant will make a profit. The short sale is ‘covered’ because, although the market participant is selling securities which it does not

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