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flash654 t1_jbkulzt wrote

Reply to comment by Drewy99 in The hedge fund that just posted the best return in history is negotiating a company-wide ChatGPT license by habichuelacondulce

The purchaser would have a claim against the bankruptcy for the value of the widgets, but would likely take a haircut on the value.

This type of account isn't odd, it's absolutely the norm. Selling promises for future delivery is baked into our economy at a very basic level. Sure, companies going bankrupt happens - but it's part of the cost of doing business and the likelyhood of it happening is low. If the buyer is big enough to hold sway or the order is large enough, they might have specific language about cases of failure to deliver. They might even buy insurance on the delivery if it's something gigantic. Say McDonalds pre-purchasing 200 thousand tons of next season's potato harvest. I'd eat my hat if a delivery contract like that doesn't carry insurance.

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Drewy99 t1_jbkx3gh wrote

>This type of account isn't odd, it's absolutely the norm.

Right I understand that, I'm just wondering what happenes in the reverse where you order 100 widgets and the supplier takes your money then goes bankrupt after only shipping 10.

You will still end up in bankruptcy held responsible by your creditors, right?

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flash654 t1_jbl3t3a wrote

I answered that, but I should have been a bit clearer.

The person who ordered the 100 but only received 10 takes a loss on the value of 90 widgets on their books. They will not receive the product and can write off the resulting loss. Additionally, they have the right to make a bankruptcy claim against the seller for the value of 90 widgets and may recover a portion of that value. Making this claim may or may not be worth it based on the time and effort required, the likelihood of being paid, and the value of the contract.

Everything else I mentioned is created specifically to hedge against the likelyhood of this happening.

Businesses like known costs, even if those costs are sub-optimal. That's why businesses might buy insurance for contract fulfillment on large orders like like I mentioned. If the value of that contract is $500 million and they take delivery over time, a business would much rather pay a 3rd party say $750k to insure the small percent chance of losing most of that value from non delivery and simply not take the risk of losing that 470 million in product, or whatever it is.

But the short and most basic answer to your question is that the buying business just takes a loss.

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Drewy99 t1_jbl5afg wrote

Thank you. Final questions -

What happens if you order 100 widgets with a pay -on-delivery agreement, pre-sell 100 widgets to other party, and those widgets don't ever get delivered by the time specified in the contract?*

Because that's what's going to happen in the case of these shorts, right?

*In this scenario the other buyer has plenty of stock and this was just a 'top-up' order for the warehouse. Because of the billions of widgets this company goes through they have a steady flow from multiple suppliers so they are not make or break counting on you.

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flash654 t1_jbla455 wrote

If we dispense with the metaphors, when a company goes bankrupt generally the value of everything goes to 0. Options values are zeroed out - so if you're short puts you'd lose and if you're short calls you'd win. Visa versa if you have a long position.

Similarly, if you're long shares then the value of the shares you have drops to zero. If you're short shares, then there is no longer anything to cover and you keep the money you received for selling your shorts minus any premium you might have paid to borrow the shares.

Theoretically you still have to "buy" the shares back to return them to who you borrowed from. but since the value of all the shares is now 0 most brokers are just going to write this off.

Lots of people have a fundamental misunderstanding of what shorting a stock is, and think that there's some theoretical limit to how much stock you can short. There isn't; If I short a stock by selling it to you, you can then lend those maybe-existent shares to someone else. This is how you can short over 100% of existing shares.

The whole market is mathematically built on the assumption that you can sell a promise to something you don't have. All the tinfoil hat folks thinking there's some huge conspiracy are barking up the wrong tree and are making the wrong argument. Everything being done is both legal and mathematically sound. The argument that everyone should be making is whether or not this is an ethical practice, and whether firms should be allowed to leverage to this extent (especially when it involves consumer money, where the customers may not be fully aware of the amount of leverage a firm is using). Tighter regulation is needed to reign in practices like this or at least make what's going on clearer, but I personally find that unlikely in the current political environment.

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