What really happens when you short a stock that then goes bankrupt?

Question

Say you short (naked "Put") 10,000 shares of Enron at 50. It goes bankrupt. You have the right to sell 10,000 shares at 50 that you don't own. But once the company goes bankrupt, its stock is no longer traded. How can you buy that 10,000 shares near zero so it could then be sold at 50?

Sell those options to whom? There is no market for those options.

This is actually a more general question. I've seen option being traded. Sometimes there are just no buyers when the underlying stock moves quickly. You are holding that option with a huge profit to be made but no buyers. So you have to acquire the actual stock or the option expires.

Answer 1

First mistake: selling a stock short is not the same as buying a put which is not the same as selling a naked put.

Second mistake: when a company files for bankruptcy, it's shares continue to be traded on the idea that it might recover from bankruptcy. This value might be only pennies per share but it is still traded. The stock might not be listed on an exchange but be traded over-the-counter under a different symbol.

Third mistake: why worry selling the stock. That path incurs a lot of commissions and loses and time value in the option. If you hold 100 put options representing 10000 shares and the market price is 1 and the strike price is 50, then those options are worth at least 490000, so just sell the options.

Answer 2

As far as put options goes ... when the option expires it would get exercised by the OCC (Options Clearing Corp) from which all options run thru. It doesn't matter if there is no market for an option like if they moved to the pinksheets. Likely as not, however, you'd get assigned long before expiration in the case of a BK like Enron.

Read more here:

http://www.optionsclearing.com/

One thought about naked puts from a guy who works high up at an online broker... even though naked puts and covered calls have the same risk scenario (not very risky in the scheme of things)....
The majority of people who blow up accounts do it from naked put selling.

And the other people gave you a good answer ... companies in BK still has stock that trades in the pink sheets.

Answer 3

Shorting a stock and owning put options are 2 different things. If you own puts, simply sell them. My guess is that the price of the put would approximately equal the strike price (less risk free interest rate to expiration).

Interesting question.

Answer 4

If the shares get delisted, canceled, and grow to be valueless, you are able to keep each and every of the money you bought them for and not ought to return the shares. you will no longer get a margin call in the journey that your place is contained in the money.

Answer 5

Then all is well for you since you just pocket the money.