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Key Takeaways
- A locate establishes reasonable grounds to believe shares can be borrowed for timely delivery.
- Borrowing, locating and completing delivery are distinct steps.
- A fail to deliver records an outstanding settlement obligation.
- The worked 250,000-share fail exceeds both the 10,000-share and 200,000-share percentage thresholds.
- Read threshold membership, short interest and borrow charges as separate inputs when comparing a trade.
What is naked short selling?
Naked short selling is a short sale in which the seller does not borrow or arrange to borrow the shares in time to deliver them at settlement. A locate establishes reasonable grounds to believe shares can be borrowed for delivery; borrowing obtains the shares, and settlement records the delivery. When the shares are not delivered, the open obligation is recorded as a fail to deliver.
Regulation SHO connects order marking, locates and the close-out of delivery fails. Bona fide market making has a defined locate exception. Rule 10b-21 addresses deceptive representations about delivery followed by a fail.
How a Regulation SHO threshold security is identified
A reporting issuer’s security becomes a threshold security when aggregate fails to deliver reach at least 10,000 shares and at least 0.5% of shares outstanding for five consecutive settlement days. The worked reporting issuer has 40 million shares outstanding. Its 0.5% threshold is 200,000 shares. Aggregate fails of 250,000 exceed both that amount and the 10,000-share minimum for five consecutive settlement days.
Threshold classification describes the aggregate condition. An individual participant’s delivery-fail position and applicable rule establish its close-out obligation.
Formula
Threshold security when fails to deliver ≥ 10,000 shares AND fails to deliver ≥ 0.5% × shares outstanding, sustained for five consecutive settlement days- Fails to deliver are the aggregate open position at a registered clearing agency, one total across all of its participants.
- Shares outstanding refers to the issuer total reported for the security.
- Cboe publishes the resulting threshold list for the securities it lists, and other primary listing markets publish their own.
Worked Example
A listed company has 40,000,000 shares outstanding. Aggregate fails to deliver at the clearing agency reach 250,000 shares and stay there for five consecutive settlement days.
- Share count test: 250,000 fails ≥ 10,000 share minimum
- Percentage test: 0.5% × 40,000,000 = 200,000 shares
- Percentage result: 250,000 fails ≥ 200,000 threshold
- Duration test: five consecutive settlement days satisfied
The reporting issuer meets the stated share-count, percentage and five-day tests for threshold classification. Its listed threshold status describes aggregate delivery fails. Each clearing participant applies its own close-out requirement to the fail it carries.
Rule 204 close-out requirements for delivery fails
Rule 204’s ordinary short-sale close-out deadline is the beginning of regular trading on the settlement day after settlement. The rule provides a third-settlement-day deadline for documented long-sale fails and qualifying market-making fails, and a separate provision for qualifying deemed-owned securities.
A missed deadline activates the applicable pre-borrow requirement. The rule permits an actual borrow or a bona fide arrangement to borrow for covered new short sales, and defines the closing purchase and settlement needed to end the restriction.
The separate FINRA Rule 4320 framework covers non-reporting threshold securities. Its threshold uses 10,000 shares and $50,000 of fail value over five consecutive settlement days, rather than the reporting-issuer percentage test.
Short interest vs delivery fails
Read reported short interest, delivery-fail quantities and the broker’s borrow terms as distinct inputs. Short interest counts open short positions; delivery-fail data records outstanding settlement obligations. For a bearish view expressed with options, the options profit calculator compares long puts and put spreads by entry premium, quantity and expiration payoff.
Limitations of naked short selling data
- A fail to deliver is a lead to check. Long-sale processing and other settlement events also produce fails, so read the fail count with short interest and the broker’s borrow terms before calling it a naked short.
- Read threshold status as the security’s aggregate condition. It is one total at the clearing agency, it flags fails that met both tests for five consecutive settlement days, and each clearing participant’s close-out duty follows the fail it carries.
- A locate gives reasonable grounds to believe shares can be borrowed; the borrow and the delivery come after it. Confirm the borrow with the broker before holding a short through settlement.
- Check the issuer before applying a test. Reporting issuers use the 0.5% test, while non-reporting securities fall under FINRA Rule 4320’s 10,000-share and $50,000 thresholds.
Bottom line
Naked short selling means selling shares without borrowing or arranging to borrow them in time for settlement, and Regulation SHO answers it with locate, threshold and close-out rules. Read fails beside threshold status, short interest and borrow terms; a fail is a lead, and the borrow and close-out record tell you what it means.
Clear answers
Frequently Asked Questions
Sources and Further Reading
- Cboe Regulatory Circular RG09-083: Rule 204 of Regulation SHO
- Cboe Regulatory Circular RG08-132: SEC Issues New Rules Regarding Short Sales
- FINRA Rule 4320: Short Sale Delivery Requirements
- Cboe U.S. Equities: Regulation SHO Threshold List
How entries are sourced, calculated and updated: editorial methodology.