I was always confused by that aspect of short-selling; I always assumed there had to always be some sort of built in time limit on the "bet" that the thing was gonna go down, but nothing is ever that simple, is it?
Either way it sure doesn't sound like the kind of game i would be interested in playing. Like (at least without implementing the safety measures you describe) you have a ceiling on how much you can make, but not lose. I mean, no matter what you're never gonna make more than the total amount you "sold" the stock you didn't have in the first place, right? (like you said, assuming the company goes out of business in the interim) Unless, again, I'm not totally grokking it.
I suppose if you're really sure company X is overvalued and going to sink, or you're just looking for a way to make money in a market that is trending down 
Like, buy general motors at 30, sell it at 40-- that I understand. 
I even sort of understand options since they were such a big topic among my silicon valley pals for a while...
but, yeah. Sounds like dude fucked up. Bet his wife is PISSED.
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