Short-Sale Ban Is Likely to Be Extended Beyond Thursday

The Securities and Exchange Commission is likely to extend a ban on short sales of hundreds of stocks beyond Thursday, when the temporary ban is set to expire, SEC staffers have told Wall Street executives.

It's unclear how long the ban would be extended. The SEC's emergency powers are set to expire on Oct 17.

An extension is expected to an include an exemption for convertible preferred shares. The SEC believes that the exemption would ensure that companies have the maximum flexibility in raising capital, the staffers said.

The short sale ban, which was imposed on Sept. 19 for two weeks, involves more than 950 stocks, most of them financial. The ban is viewed in many quarters as an artificial stimulus likely to wear off once normal trading resumes.

Short sales involve an investor selling borrowed stock in the hopes of replacing it later at a lower price. Short-sellers have been blamed for driving down the price of financial stocks, which led to a temporary ban over the summer and a second ban during September.

Some worry that the short-sell ban gives an artificial boost to bank stock prices that could come back to haunt investors later.

In turn, those holding sizeable portions of the stocks, such as employees of larger institutions like Goldman Sachs and Morgan Stanley can benefit the most from the ban on shorts, while the rest of the market could be set up for trouble.

"They're totally inflating it," says Dave Rovelli, director of US equity trading for Boston-based Canaccord Adams. "Once this ban gets lifted the (bank) stocks are going to get annihilated. Nothing's really changed."

Rovelli is among many traders who believe the short-selling rules were unnecessary. Instead, he thinks that if the uptick rule, which forces shorts to wait for a buyer willing to pay more than the last trade, was put back in place, that would have put a lid on short selling.

The rules also could inspire a false confidence in the overall market, another factor that could bite investors who are taking money off the sidelines to get back into stocks.

Still, other countries around the globe are following the US lead and instituting sharp restrictions or outright bans on shorting. Moreover, there is speculation swirling that the US deadline could be extended until the end of the year, or at least past the presidential election.

But some advisers are telling their clients to wait until the short rules expire before taking aggressive action, on belief that the market will drop after that and set up nicely for bargain hunters.

Options traders fear that the short selling rules are taking equity out of the market and causing even greater risk to options traders who can't short to cover their positions.

"I just see it as kind of putting the brakes on the inevitable," says options trader John Carter, who is president of Trade the Markets. "It can't stop a process. If a company is losing money and it's going to go bankrupt, the short-selling rules aren't going to help it."

© 2012 CNBC.com