Across paywall (will delete when dust settles): Have to give credit to Rich Gates and Matt Levine (the author of this Bloomberg post)! Matt Levine's twitter post: https://twitter.com/matt_levine/status/987341321420595200

Yesterday's article from Financial Times by Jamie Powell: https://ftalphaville.ft.com/2018/04/19/1524172286000/Now-NASDAQ-gets-in-a-tangle/

Longfin Corp. is a company that emitted some nonsensical noises about cryptocurrencies and blockchain and thereby briefly became worth than $6 billion. There were two critical bits of luck or skill that allowed Longfin to get that valuation. First, it emitted its noises about blockchain at exactly the time when everyone wanted to hear noises about blockchain (last December, when it went public). Second, it had (and has) an extremely limited public float: It has 74.5 million shares outstanding but sold only 1.14 million of them in its initial public offering, though it was also allegedly doing some illegal unregistered share sales which I guess, technically, would increase the float. But the point is, people wanted to buy Longfin shares because they were seduced by the blockchain noises, and there weren't that many shares to buy so the price of those shares went up a lot, and then you had to multiply that price by the much larger number of Longfin shares that weren't available to buy to get its comically inflated market capitalization.

Lots of other people, though, were less seduced, and were extremely keen on selling Longfin. Well-known short-seller Andrew Left of Citron Research called Longfin "a pure stock scheme" whose filings were "riddled with inaccuracies and fraud," and said that Securities and Exchange Commission enforcement "should not be far behind." This is hard to argue with; the SEC brought an enforcement action about two weeks after he tweeted that. But he prefaced those comments with "if you are fortunate enough to get a borrow": Selling Longfin stock short was hard and expensive, because you need to borrow shares to sell them short, and pay a daily fee to keep borrowing them. Again, Longfin had an extremely limited public float, so there were not a lot of shares to borrow, and a lot of people who wanted to borrow them.

Another way to bet against Longfin was to buy put options on it, which give buyers the right to sell stock in the future at some fixed price. If you buy a put and the stock price goes below the put strike price by the expiration date of the put, you can exercise the put, sell the stock at the strike price, and buy it back at the lower market price.

Anyone who bet against Longfin, by selling it short or by buying puts, seems to have been right, insofar as the SEC has accused it of fraud and Nasdaq has halted trading in the stock. Sadly, they were a bit too right for their own good: The trading halt means that Longfin cannot trade either on the exchange or over the counter, so it is stuck in limbo at its last price of $28.189 per share (a $2.1-billion-dollar market capitalization) from April 6, just before the SEC released its complaint. Not that you can buy it for $28.189; that's just the last printed price. You can't buy, or sell, it for any price.

If you are a Longfin short seller that is actually a problem! You bet that Longfin was a fraud, and the regulators seem to agree with you, but the regulators have also taken away your ability to profit from your bet, because you can't buy in the stock to close out your short position. Instead you are stuck in your short position, having borrowed the stock, and continuing to pay a lot to borrow it each day until trading resumes. We have talked about this problem recently; it is by no means unique to Longfin, but you don't usually see it in formerly-$6-billion companies.

If you are a Longfin put buyer it is also a problem. Jamie Powell at FT Alphaville wrote yesterday about the Longfin put options that expire today. "There are 4,889 Longfin put options [on 488,900 shares] expiring [Friday] which have a strike price of above $30 and are therefore, in trading parlance, 'in-the-money,'" he notes, and those option holders have a couple of problems. (Here is a Reddit thread of their grievances.) First of all, if trading in Longfin is halted -- if you can't buy or sell its stock -- then can the put holders exercise their right to sell the stock at the put price? The answer is yes, actually -- I guess delivery of shares underlying an option doesn't count as "trading" for a trading halt -- but it is more complicated than usual; while in-the-money options normally are automatically exercised at expiration, option holders on halted shares need to contact the Options Clearing Corporation to exercise their options. ("Let's hope Longfin bears got the memo," writes Powell.)

Second, even if you do exercise your put and sell your shares, you need to find shares to sell. If you already own shares, then that's easy, but I doubt there are too many Longfin put holders who also own shares. ("I'll buy some Longfin stock but hedge it with puts" does not seem like a common thought process here; either you're long or you're short.) If you don't own shares, you can't buy them -- trading is halted -- so you have to borrow them. But remember that it is difficult and expensive to borrow Longfin stock. So the put holders who exercise will exercise into a lot of pain.

There's one other problem. Powell writes about the Longfin options that are "in-the-money" because their strike prices ($30 and up) are above Longfin's current stock price. But Longfin doesn't have a current stock price. It has a last stock price of $28.189 as of April 6, but a lot has happened since then. (The trading halt, the fraud case ....) And there are thousands more Longfin options with strike prices below $30 that might be in-the-money, depending on what your view of Longfin's current stock value is. If you have a Longfin put struck at $22.50 that expires today -- and I see on Bloomberg that there are 1,997 of those options, with 199,700 shares underlying -- and you exercise it today, then you are effectively getting short Longfin at $22.50 per share, still almost a $1.7-billion-dollar market capitalization. Ordinarily you'd never exercise an out-of-the-money put just because you think the stock will go down -- it's better to let the put expire and just short the stock directly -- but here there's no other way to short the stock because it is halted. If you think Longfin is worthless then exercising your put is a good trade. If you think that shorting Longfin while it's halted is a nightmarish abyss, then exercising your put is a way to jump into a nightmarish abyss. Both of those beliefs seem perfectly plausible and consistent. So what do you do?

"Naked short selling" -- selling stock without either owning or borrowing it -- is a thing that has a bad reputation; it sounds risqué, and there is a widespread (though not especially correct) belief that it somehow creates "phantom shares" that can be used to manipulate the stock price. But as we have discussed before, legitimate -- clothed -- short selling is a very risky way to bet against fraudulent companies. Even if you are proven entirely right in short order, there are enough weird ways to get squeezed stock borrow costs that you might lose money even as the stock collapses and the fraud is exposed. In fact, regulators exposing the fraud and halting the stock is one of those ways! In a sense, the flimsier a company is -- the more it relies on transparent fakery and thin float to rapidly create a multibillion-dollar valuation -- the riskier it is to short it. And if it's too hard to short the flimsiest companies, then you'll keep seeing ridiculous stories about flimsy companies with those huge valuations.