Haha yeah the pronouns are not the clearest in this. Let me try:
Let's set up three parties to this scam:
1. The Scammers - these people start the company
2. The Short Sellers - these are the "smart money" who uncover some fictitious/sketchy company and want to profit
3. Brokers - these are the intermediaries through which both The Scammers and The Short Sellers trade
First, The Scammers set up the company and take it public on some sort of lightly regulated exchange (look up pink sheets, over-the-counter trading, etc.). These are not the NY Stock Exchange where an IPO has to be somewhat legitimate.
Second, The Scammers lightly trade the stock up among themselves over time until it looks overvalued enough for The Short Sellers to notice it in their quantitative screens and get interested.
Then, expecting the price to drop, The Short Sellers decide they want to sell short the stock. This would generally mean that they borrow the shares from someone that has them (e.g., borrow 100 shares at $10 a share), sell them to someone else (e.g., all 100 shares at $10 a share), and buy shares again when the price goes down (e.g., buy 100 shares at $2 a share) to repay the person they bought them from (to whom they owe 100 shares, regardless of share price).
So, in order for the Short Sellers to orchestrate this, they turn to Brokers, who match buyers and sellers. Since this company is a scam, only The Scammers have any shares. So the Brokers go find The Scammers (hopefully not realizing they are scammers), and ask them to lend their shares to The Short Sellers. The Scammers gladly do this.
Next, the Short Sellers want to sell their borrowed shares back to someone, so they are set up for when the price drops. Again, The Scammers are glad to buy these shares (putting up some cash to do so).
When enough Short Sellers get involved, or when The Scammers feel like it, they will call up their Brokers and ask for the shares they loaned back. There are some rules around this, but they can generally call them back. Now begins an epic short squeeze - the Short Sellers don't have any shares, but they owe them to someone, not realizing that the person they borrowed from is the same as the person they sold to (The Scammer in both cases).
So, the Short Sellers go out looking for shares to buy to repay their loan (again, denominated in shares, not cash). But since only The Scammers have shares, they can demand any price, and they do. They demand higher and higher prices, until the Short Sellers finally have to pay up exorbitantly for shares to pay back their loan. The Short Sellers buy shares from The Scammers at wildly high prices, and return them (through a Broker) to The Scammers, who are very pleased with themselves, having both sold their shares for 100s of times what they bought them for, and having gotten the shares returned to them.
Ok, that is helpful. I'm still a bit confused though. (where's collida when you need him?)
So I get the point where the scammer is selling options amongst themselves to get the stock price to rise. I put out an "ask" and then later come back with another shell company/identity and buy that stock with my "bid". Brokers are handling these transactions by connecting the buyers to the sellers (which happen to be the same people so they can buy an sell at an arbitrary price and only the brokers are making any money on the transaction fees.)
Now you stipulate this causes the stock to show up as "over valued" based on pretty standard technical analysis. Sort of "look no revenue but people are buying this stock for $2? WTF?"
So our short seller (who isn't a scammer right? they are being scammed?) goes to their broker and says we think this price is too high and its going down, so we want to sell a put option (that is the promise of a sale) of these shares at $2 a share, 6 months from now. Since they are an options trader and they know how these things go, they also buy a call option, to buy shares at $2.25 6 months from now. This is known as a "butterfly" if the shares go up you will be able to cover your put options with shares from the call option and "lose" only 25 cents per share, if the shares go down, the person on the other side of your put buys your shares for $2 and you sell them for less than $2 and pocket the difference.
What I don't understand is what broker is going to play the other side of the short seller's order book?
If our scammers agree to sell a call option at $2 to counter balance the short seller's put option, they are forced to sell at $2, they can't decide to sell at $20.
How does the scammer get the short seller's broker to take a bath here? They aren't some dupe in an investment club who things "its going to the moon!" and so buying what ever comes out, they are trading options on high risk securities over the counter (in many ways the highest risk securities).
So the only way I see this working is if the broker in this melodrama is corrupt and telling someone to short a stock which the broker does not ever get control over (essentially con them into a naked short).
And why is this scheme illegal? Isn't it Short Sellers' fault that they have borrowed shares without reading the conditions properly? They could just buy them.
It looks like a casino where you are allowed only to lose, not a free market where you can trade however you like. Once you find a profitable scheme you go to jail.
Let's set up three parties to this scam: 1. The Scammers - these people start the company 2. The Short Sellers - these are the "smart money" who uncover some fictitious/sketchy company and want to profit 3. Brokers - these are the intermediaries through which both The Scammers and The Short Sellers trade
First, The Scammers set up the company and take it public on some sort of lightly regulated exchange (look up pink sheets, over-the-counter trading, etc.). These are not the NY Stock Exchange where an IPO has to be somewhat legitimate.
Second, The Scammers lightly trade the stock up among themselves over time until it looks overvalued enough for The Short Sellers to notice it in their quantitative screens and get interested.
Then, expecting the price to drop, The Short Sellers decide they want to sell short the stock. This would generally mean that they borrow the shares from someone that has them (e.g., borrow 100 shares at $10 a share), sell them to someone else (e.g., all 100 shares at $10 a share), and buy shares again when the price goes down (e.g., buy 100 shares at $2 a share) to repay the person they bought them from (to whom they owe 100 shares, regardless of share price).
So, in order for the Short Sellers to orchestrate this, they turn to Brokers, who match buyers and sellers. Since this company is a scam, only The Scammers have any shares. So the Brokers go find The Scammers (hopefully not realizing they are scammers), and ask them to lend their shares to The Short Sellers. The Scammers gladly do this.
Next, the Short Sellers want to sell their borrowed shares back to someone, so they are set up for when the price drops. Again, The Scammers are glad to buy these shares (putting up some cash to do so).
When enough Short Sellers get involved, or when The Scammers feel like it, they will call up their Brokers and ask for the shares they loaned back. There are some rules around this, but they can generally call them back. Now begins an epic short squeeze - the Short Sellers don't have any shares, but they owe them to someone, not realizing that the person they borrowed from is the same as the person they sold to (The Scammer in both cases).
So, the Short Sellers go out looking for shares to buy to repay their loan (again, denominated in shares, not cash). But since only The Scammers have shares, they can demand any price, and they do. They demand higher and higher prices, until the Short Sellers finally have to pay up exorbitantly for shares to pay back their loan. The Short Sellers buy shares from The Scammers at wildly high prices, and return them (through a Broker) to The Scammers, who are very pleased with themselves, having both sold their shares for 100s of times what they bought them for, and having gotten the shares returned to them.