A long position is the phrase used by financial market traders to describe owning an asset.

By contrast, a short sale is when traders borrow an asset that they think will fall in value and then sell it, intending to buy the borrowed asset and return it at a lower price later. That’s called a covered short.

In a naked short sale traders sell an asset they haven’t even borrowed, aiming to take advantage of the time lag between selling the asset and settling the actual payment.

Financial markets are filled with comical terminology. Think—really think—about a ‘bull market’, a ‘real estate bubble’, or a ‘dead cat bounce’. But few phrases conjure up a smirk quite like ‘naked shorts’, which are a kind of bet on a falling stock price that is somewhat frowned upon in financial circles. So what is a naked short sale?

Sandeep Dhawan came on A Dictionary of Finance podcast to talk about shorts. He explained how naked short sales work, as well as how covered shorts work, and mentioned that short sales are often seen as somewhat immoral, even though they are legal.

“Shorting should be natural activity,” says Sandeep, who works in the Capital Markets Department of the European Investment Bank. “There is no law that says assets only go up. Expressing a view, long or short, should be equally legitimate. But for some reason shorting is looked upon askance.”

He gets into the details of how naked short sales work, too, because of the opportunity to take advantage of the time between an agreed transaction and the actual exchange of payments, which can be up to a week.

In a naked short, he says, “I don’t have to give you anything. All I’ve done is entered into a contract that you buy the asset off me at today’s price. In two days, when it drops, for example, I buy it back, and seven days later we settle up the original transaction. I didn’t even need to borrow the security to make good on my settlements.”

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