A Short Squeeze is a widely known reason for short sellers to close out (buy to cover) their short positions when they incur large mark-to-market losses and\or stock borrow rates spike, but the other side of the coin is closing out a short position in order to realize mark-to-market gains.
We are looking at stocks with short interest that has averaged over $50 million since April 1st . The Profit\Loss includes stock borrow costs and mark-to-market profits and losses on daily short positions. The Total Net P\L% is simply Total Net P\L$ divided by Average Short Interest since April 1st.
Over the first two weeks in April, domestic equity shorts averaged $689.3 billion of short interest with a Total Net P\L of -$68.9 billion, -9.99%, over those two weeks as the S&P 500 rallied +9.88% and the Nasdaq rallied +10.06%. Overall there were 12,291 shorted stocks in our dataset with only 16% of these short trades being profitable in the first half of April, generating just +$3.19 billion in mark-to-market profits, +7.10%. On the other side of the ledger, 50% of the shorted stocks in our dataset generated mark-to-market losses of -$72.08 billion of mark-to-market losses, -11.25%.
The stocks most susceptible to short squeezes are those with high stock borrow costs and large mark-to-market losses. These are short sellers that are incurring losses while paying a steep premium to stay in those equities. There were only eighteen shorted stocks with over $50 million in short interest with stock loan costs over 10% fee and mark-to-market losses over -5%. Mallinckrodt and Gamestop top this list and are the only stocks with two-week losses over -65% and stock borrow costs over 40% fee and are the prime targets for a short squeeze if their stock prices continue to strengthen.
If we disregard stock borrow fees and just look at net-of-financing mark-to-market losses we see a broader list of shorted stocks that can be susceptible to a short squeeze, albeit to a slightly lesser extent than shorted stocks with both high fees and losses.
It is beneficial to look at these stocks in two tranches, Mid\Small\Micro cap stocks which are used primarily as Alpha plays and less as Beta portfolio hedges and Mega\Large cap stocks which have the potential to be dual use stocks as Beta (hedging) and Alpha (risk) plays.
The following chart shows the Mid\Small\Micro cap shorted stocks with the largest net-of-financing mark-to-market percentage losses. These are stocks which short sellers may begin to cover, get squeezed, as their losses mount.
The following chart shows the Mega\Large cap shorted stocks with the largest net-of-financing mark-to-market percentage losses. These are stocks which short sellers may begin to cover, get squeezed, as their losses mount if they are primary Alpha (risk) plays, but may continue to keep on their books regardless of the losses they incur as they are part of an overall portfolio hedging strategy.
Usually, in a rallying market, we would see hedging stocks like Amazon (AMZN) and Apple (AAPL) high on the list, but the top twenty-five is chock full of risk and recent over-performing sector names. The Mega\Large cap names with the largest net-of-financing mark-to-market short losers are Tesla (TSLA) which is continuing its +70% run in 2020, gold and mining stocks and oil & gas stocks.
With the domestic stock markets still down significantly in 2020, the vast majority of short trades are “in the money” and diligent traders are preparing exit strategies for their profitable short positions as the markets begin to trend upwards.
If these short sellers see their sizeable unrealized profits begin to get eaten away by a rebounding stock market, there is a good chance that they will start buying back shares to lock in their remaining profits. This would provide an additional boost to the stock’s price as they trade alongside long buyers on the bid side of the market.
The following chart shows the most profitable shorted equities with an average short interest over $50 million for the first two weeks of April. These are the names that shorts will cover quickly if stock prices rise and start eating into their mark-to-market profits.
The most obvious “profit based short squeeze” is Luckin Coffee (LK) as it is up $676 million in just the last two weeks. Surprisingly, we have been seeing continued short selling in the stock even after its April 2nd beat down. Shorts made +$583 million in mark-to-market profits on April 2nd, but short sellers not only rode their profits, they increased their bets slightly and made an additional +$64 million in mark-to-market profits through April 14th. If LK’s stock price rebounds, we can expect a large and sudden surge in buy-to-covers as shorts rush for the exits to realize their outsized profits in the name. With long shareholders and short sellers both on the buy side of the market a short-term spike in LK’s stock price is not out of the question.
Short squeezes in this market are difficult to predict with wild upward and downward price swings almost a daily occurrence. These price moves quickly turn short winners into losers one day and back into winners on the next day. But, using our Black App and Blacklight SaaS platform to see daily moves in stock borrow costs and mark-to-market profit & loss investors can tee up a set of potential trades and execute when the market turns in their favor. Adding a “potential short squeeze” metric to a trading arsenal can be the difference between participating in a winning trade or sitting on the sidelines mumbling shoulda, woulda, coulda.
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Managing Director Predictive Analytics, S3 Partners, LLC
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