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. With the domestic stock markets down over 20% in 2020, the vast majority of short trades are “in the money” and diligent traders are preparing exit strategies for their profitable short positions when 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 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.
I’ve split my analysis of the domestic short market into three groups: Mega & Large Cap stocks; all other market cap stocks with short interest >$100 million and all other market cap stocks with average short interest < $100 million. The Average Short Interest and Mark-to-Market Profits are calculated from February 19th to March 22nd. The Mark-to-Market P\L% is simply the MTM P\L$ divided by the Avg Short Int.
Although mega and large cap stocks may have large P\L’s during this time of market volatility, they are also used as portfolio or derivative hedges and therefore short sellers may not be as prone to close out profitable positions since they are not used solely for Alpha generation.
Mid and smaller market cap securities may be used as market or derivative hedges, but they are primarily used for Alpha generation. Short sellers in these stocks may be quick on the trigger to trim their positions if they start seeing their accumulated mark-to-market profits starting to disappear and push stock prices even higher.
The following stocks with less than $100 million in average short interest will behave similarly to the group with over $100 million of short interest, but the effect on the bid side of the market will be less robust simply because there are fewer shares to cover.
Although there are very few Short Squeeze candidates in such a downward trending market, there are quite a few Squeeze Release candidates. When the markets begin their recovery, there will be a slew of short covering by short sellers who are trying to lock in their mark-to-market profits. These shorts will add to the buying demand of the dry powder in the market that is looking to buy off the lows and create an even steeper “hockey stick” price move in these more heavily shorted stocks. Buying a big short winner today may prove to be an even bigger long winner tomorrow.
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Managing Director Predictive Analytics, S3 Partners, LLC
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