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With all the talking about short selling the last few weeks I wonder what happens to shorted or even naked shorted positions when the short seller goes broke.

Who looses when the short seller does not have enough money to buy back the stock sold short?

Does the lender not get his shares back?
Do the buyers shares disappear?

Any educated guesses?

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I'll take a stab at it. If you're shorting, it's probably on margin (I don't know if they changed it,but it was 50% of what you wanted to borrow) and have other assets to back your short position. In other words, you may have a naked short of xyz stock but own enough abc stock to cover the loss. Margin calls don't happen all that often, but if the broker thinks there may be a problem with the share re-purchase, they will do a margin call and the short seller would be forced to sell other stocks, bonds or assets to cover the loss.

In any event, should the worst possible case happen, the broker will buy back the shares (replacing the borrowed shares used in the short sale) and go after the short seller's assets to cover the loss.

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Thanks for your stab.

For retail shorts, that was my line of thought as well, the broker takes the hit. But given the recent epical fails of large institutions, I wonder what happens if a higly leveraged short selling hedge-fund (or however you want to call the vehicle) goes belly up.

This report on NPR started my thinking:
SemGroup, an oil trading company folded after betting the wrong way. As a result many oil producers (and probably also buyers) are left holding bags.

I guess the question expands to any derivate trading. What happens if the issuer of options can't step up to his promise to buy/sell the stock for the contracted price? E.g. what happened to options bought/sold by LEH?

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