The SEC has come out with permanent rules to solve the problem caused by naked short selling.  The pivotal problem is the exploitative danger of manipulation of volatility and resulting down spiral.

The problem with regulatory approaches is a preference to add patches onto a bad system instead of re-engineering the whole system (for instance, The Federal Reserve System).  The key to a solution to the short-selling dilemma is to RECOGNIZE THAT THE CAUSE OF EXPLOITATION IS A FUNCTION OF VOLATILITY THAT IS A FUNCTION OF TRADING VOLUME.  Every dark pool operator (like SigmaX or LiquidNet) and networked crossing network (like Instinet or Posit) recognizes this and this is the essence of modeling trading algorithms to reduce execution costs.

The solution I propose (as a simple Equity Overlay Manager) is this:

TURN THE SHORT INTEREST THAT AFFECTS VOLATILITY AS A FUNCTION OF TRADING VOLUME INTO DILUTION THAT WOULD GREATLY MITIGATE THE VOLATILITY AND LESSEN EXPLOITATION.

How can we change Short Interest Short Selling into Dilution?  Easy.  Withdraw all rules regarding restraint of short selling and require that the short interest be covered periodically with the underlying company issuing stock to cover.  This would cause an accounting entry to decrease Treasury Stock and increase Assets (Cash) to the company and require brokers to cover – not from the markets – but from the companies themselves.

This would be a form of “MINI-PIPES” but instead of manipulating VOL as a function of trading volume – the VOL would be affected in the form of DILUTION that is a very mild form of VOL.  The value-added from this transformation of Short Interest to Dilution would be the price volatility caused by shorting versus the Dilution Formula for warrants (not options because we are CREATING shares in issuance) defined by the formula:

[(MV of Outstanding Shares) + (Value of Treasury Stock)] divided by (Total number of shares after Dilution).  While it may not be apparent in this script form, it should be noted that the dampening of VOL and drawdown that can cause a death spiral of stock price on illiquid securities would be tantamount to turning a tire blowout into a slow leak that essentially demotivates exploitative manipulation.

Peter J. de Marigny / DITMo Equity Hedge & Overlay Strategies / AMERICADE / DITMo Capital