2. You sell the 100 shares for, say, £1000 in total.
3. Prices for the share ideally go down. (You and others have been selling, after all)
4. You then buy 100 of the shares for, say, £900 in total
5. You then give the broker the 100 shares back
6. You've made £100
Normally the broker would charge a commission for the lending, hence his/her motivation. So if the commission were £10 you'd have £90 profit.
Naked short selling is when you miss out the broker. So you don't owe the broker anything, but you still need to give the buyer of your fictional shares something real, so you end up buying them, at a hopefully lower price, later.
Defenders of short-selling claim it helps quickly respon to fundamentals in the market place. For instance once we heard the US might fine BP people could start selling BPs shares without owning them (yet).
What if the lender decided to sell the stocks that he had lent out? Would the trade need to be closed for the short seller, or would he have to repay immediately and short sell a new lenders stock?
Either they were borrowed from the brokerage firms inventory or they were borrowed on margin from another clients account. If they're borrowed from the firms inventory, it's unlikely the short seller will be affected, because the firm will just have you borrow against different shares in their same pool of inventory. If they have no more left, they can borrow from another firm. In the very unlikely scenario that the firm decides to not hold ANY more shares of that company, then you may get called on the stock.
In the second scenario, if you're borrowing from another client, however, you may be at risk of getting a margin call -- in which case you would need to purchase the shares on the open market at their current price and return them to the lender.
The answer depends on the agreement between the lender and the borrower.
Suppose that I loan you my car and then decide to sell it. One possibility is that my agreement with you doesn't let me sell it (or forces me to come up with another car for you if I do). Another possibility is that my agreement with you says that the loan to you ends if I decide to sell.
Short selling is a form of borrowing. The only odd thing is that the thing that you have to repay isn't cash.
Consider a mortgage. The borrower rarely has enough money to cover the whole loan when it is taken out. Instead, the borrower hopes to have enough money to cover each payment as it occurs.
And we might get sane Price to Earnings ratios.