Shorting stocks almost has a sexiness surrounding it — if anything remotely related to investing and trading could be considered sexy.

It tends to evoke images of men in suspenders with cigars and whiskey snifters, discussing what company they should kill next in the stock market.

Unfortunately, this image was sharpened this past week as the U.S. Fed, the British Parliament and the Australian government outlawed some or all shorting to protect over-leveraged or fundamentally lousy financial institutions from what they said were unfair attacks on their stocks.

To that, all I have to say is this: Remember how well Prohibition worked out the last time the government outright banned something that subjective public officials decided was bad?

That action bred even more destructive behavior, and the real criminals still profited while the innocents went under as rum-running goons grew rich, branched out into other industries and brought their corruption with them.

SHORT-SELLERS AREN’T NECESSARILY THE BAD GUYS

Well, we may not see a new “Scarface” emerge from this, but believe me when I say that some legit traders are being affected by this move to stop the shorting of 799 financial stocks till Oct. 2.

And those legit traders include you and me, because even though we may not be directly shorting stocks, as options traders we enjoy the ability to buy puts as the safer, saner way to go short. And while we can still trade puts, the playing field is a lot rockier.

Too bad the “good guys” have to get punished because of greed and irresponsibility in the companies that are being protected. But will this temporary action be the cure-all that Wall Street is hoping for, or are the toxins simply going to burst forth at full force when the short-selling ban is lifted next week?

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SHORTING IS ALMOST SECOND-NATURE TO SOME TRADERS

You must remember that shorting in all of its forms is now a common occurrence — it isn’t anywhere as illicit as sipping hooch in a speakeasy. Variations such as naked shorting have been in the headlines for many months.

In mid-2007, the SEC ended the uptick rule, which the occasional TV pundit claims is the cause of the markets’ decline. (Never mind the fact that nothing was done to improve the quality of the terrible stocks that were being shorted!)

Then — after one year, lots of volatility and $100 billion in shares — shorting is as natural to many investors as going long.

The really unfortunate thing is that, essentially, this new short-selling ban won’t address the real problems with financials like Citigroup (C), Merrill Lynch (MER), Morgan Stanley (MS), Sovereign Bank (SOV) or Wachovia (WB).

I’ve been warning my ChangeWave Shorts readers, and anyone who will listen on the Fox Business Channel, that these investment banks’ balance sheets are atrocious, and that more write-downs will be forthcoming and forward earnings will suffer because they are selling off the very assets they need to regenerate profits and earnings.

SO WHAT HAPPENS NOW?

I foresee a lot of suspended dividends and stock valuations that will go kaput. The simple fact is that investors should be shorting these companies because, fundamentally, they are a wreck.

But, what really spurred the government to step in is that the “dark side” of the shorting world — the guys with suspenders, so to speak — started attacking some of the financials that were solid — making innocent companies guilty by association.

And, the respective governments instituted the bans as a way to keep the perceived “bullies” from stealing the little guy’s lunch money.

But, I’m here to tell you, that what they’ve done is actually removed the teachers from the school.

WHY SHORT-SELLERS ARE SAFETY NETS

What I mean is that there are two kinds of short-sellers: the back-alley bullies sipping their whiskey and plotting the demise of good companies, and the protective kind of market-makers who short-sell and keep things in check for the market to hedge some of their long-side bets.

Their actions ensure that the marketplace is liquid and fair for the rest of us. They make sure that you and I — by and large — don’t pay exorbitant options premiums.

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Bottom line: Despite what happened last week, shorting — in all of its forms, whether it’s short-selling stocks, buying puts, or selling calls and puts — is integral to the liquidity and functioning of the market.

Fortunately, it’s not going away — but it’s been knocked down a peg and the hurt is going to spread. We already saw that in the options markets today.

Consider that options — put options in particular — are essentially insurance for the financial market. We need market-makers in the options realm to supply a kind of safety net for portfolios. Of course, if they reduce some of the risk for investors like you and me by writing put options, they must offset some of the risk they take on for hedging that bet.

In normal markets (whatever those are anymore) the market-makers would diffuse some of their risk from offering put options by short-selling the underlying stock.

Now, of course, they can’t do that (at least in the financial sector domestically). That means there is all of this extra risk floating around with nowhere to go except to artificially inflate prices. In the same way that gas prices often increase when there is a “perceived threat” from a forecast storm, put premiums have elevated to ridiculous levels.

I’m as patriotic as the day is long, but here is where we should’ve taken a cue from the United Kingdom. While it enacted a similar ban on short-selling financial names, U.K. options market-makers are still allowed to short-sell as a way to offset some of the risk they take on.

WHERE DO WE GO FROM HERE?

“Coulda, woulda, shoulda,” well, ain’t gonna to help us now.

Unable to perform their usual protection duties and with options traders still demanding to buy puts and sell calls, the market-makers’ hands are tied — and it’s got the options markets tied in knots.

Their ability to short stock against their option positions is an essential piece of what they do. Without that piece, the system is off-kilter.

We’re already seeing the effects. Today’s negative close came about, in part, because the market-makers have nowhere to seek shelter, so to speak, and put options’ values have mounted as a result.

The good news, of course, is that even with the government’s ban, you can still profit from playing the short side of the financials by buying put options. The bad news is that, at least in the interim, you’re likely to pay a lot more for them.