Tag: Shorting

What Can You Learn From the Short Interest in a Stock?

Posted on by phoffman@channelchek.com

Using Short Interest as an Evaluation Tool

Not everyone involved in the stock market are buying stocks in expectation of them rising. Some market participants are selling, in the expectation that the price will fall. This selling is one of many factors impacting a stocks current price – and could influence future moves. Understanding short interest in a stock that you are active with may provide trading ideas or send warning signs.  Below we define short interest, its impact on stock prices, where to look to find the short interest on a particular company, how the information is used, and of course, risks.

What Short Interest Is

Short interest refers to the total number of shares of a particular stock that have been sold short by investors. In simple terms, when an investor “shorts” a stock, they borrow shares from a broker and sell the borrowed shares in the stock market. If all goes well, they buy the shares back in the future, then return them to the broker along with the interest cost (rebate rate) of the borrowed amount.  

Short interest is expressed as a percentage or a number, indicating the total shorted shares relative to the stock’s total float or outstanding shares.

What it May Do to the Stock Price

There is more than one possible meaning of a stock having high short interest. One is that the high percentage of short stock outstanding could mean that there is a large number of investors betting against the stock’s performance. This suggests a bearish sentiment and potential bearishness regarding the stock’s future price moves. If many market players continue to remain bearish, the high or escalating short interest can put downward pressure on the stock’s price.

Conversely, a low short interest might suggest a positive sentiment among investors or confidence in the stock’s future performance. It shows the stock has limited potential for a short squeeze, where short sellers are forced to cover positions and the buying causes the price to rise.

How to know the Short Interest of a Stock

Investors can find short-interest information through many sources, online brokerage platforms, financial news websites, and some stock market research portals. Notable financial websites often provide this data alongside other relevant stock information. Additionally, the U.S. Securities and Exchange Commission (SEC) requires institutional investors to disclose their short positions in certain cases, making this information publicly available.

Example of Short Interest Reported on a Popular Brokerage Platform

The short interest of GameStop (GME) on this day was 20.78% of outstanding float (Source: TD Ameritrade)

Trading With Short Interest Information

Knowing if the short-interest in a company is trending higher, lower, or is stagnant is more helpful than a snapshot of one day’s percentage.

The short interest data can be traded on in a few ways. High short interest can serve as a contrarian indicator. If an investor believes the company has good prospects and it has a high short interest, a price-moving short squeeze could occur if positive news unfolds or strong financial performance triggers buying. This scenario can push short sellers, that are perhaps faced with margin calls, to cover their positions rapidly, resulting in a sharp upward movement in price.

The use as a gauge in market sentiment toward the company, and which way it is trending, can allow you to understand investor behavior over a period of time toward the stocks. Combine this with other fundamental and technical analysis, and short interest data can aid in improving your probability of either a successful trade or successfully avoiding a potential problem.

Short Interest Not Definitive

While short interest can provide valuable insights, it is crucial to understand the risks involved. Short interest data alone is rarely enough to be the sole basis for an investment decision. It is important to conduct or gather comprehensive research and analysis of the stock’s fundamentals, industry trends, and market conditions. Evaluating short interest comes after higher level filtering of a company’s prospects.

Remember, short interest size and trend might not always accurately reflect the actual market sentiment. Market dynamics can change rapidly, and short sellers might cover their positions quickly, resulting in a shift in the stock’s performance. Therefore, investors should consider short-interest data as just one piece of the puzzle and not solely rely on it for investment decisions.

Take Away

Short-interest statistics hold a role in providing insights into market sentiment and potential investment probabilities. Investors can find short-interest information through various sources, enabling them to assess market sentiment and potential short squeezes. However, it is best to use short-interest data in conjunction with comprehensive research and analysis, as it should not be the sole basis for investment decisions. More informed investment choices, it stands to reason, lead to a higher likelihood of success or avoiding failure. By understanding short interest and its implications, investors can enhance their understanding of either a stock, or even the market in the aggregate.

Paul Hoffman

Managing Editor, Channelchek

When Shorting a Stock Becomes Illegal

Posted on by phoffman@channelchek.com

Crossing the Line into Naked Short Selling

Shorting a stock by itself is not illegal and can even be thought of as helping the liquidity in the company’s shares as many more continuously change hands (volume). Brokers and institutional investors can also reap additional benefits. For all participating investors, it allows the opportunity for money to be made as long as the stock is moving up or down. However, among the legal shorts, there are illegal short positions being made. This has been the subject of controversy, Volkswagen in 2008, GameStop 2021, and AMC which has worked to end attempts of this kind of activity in its stock.

The Upside-Downside of Legal Short Selling

Selling a stock that you don’t own puts you, the seller at a greater risk than buying a stock. The reason is simple, stocks can theoretically go up by an infinite amount, however, they can only go down by their current value. If your shorts go up, you are losing value in your position. With this risk in mind, selling shares you don’t own, or a shorting strategy, certainly can work in your favor if your risk management short-circuits are in place and the stock’s value erodes.

A legal short position involves your broker borrowing shares on your behalf, perhaps from a large institutional holder, paying them a daily accrual rebate rate (interest) during the period that you hold the short position. The strategy is to buy them back at a lower price in the future than what you sold them at today.

Crossing the Line to Naked Short Selling

The word “naked” when it comes to most investments, suggests that you are without that which you are trading. If the same amount of shares has been borrowed on your behalf or by you as part of your short transaction, you are not naked in the position.

Naked shorting is the illegal practice of short selling shares that have not been affirmatively determined to exist. This can happen when there are so many market players thinking shares will decline in value that more shares are sold than obtainable to back up each trade.

Despite the SEC making this illegal after 2008 in response to some failing investment banks that had been sold beyond the number of shares in existence, naked shorting still goes on today.

One example still fresh in many self-directed investors’ minds is GameStop (GME) shares. In 2021, traders reportedly sold short around 140% of GME shares outstanding. This meant a substantial amount of shares of the company were sold that didn’t exist. What allowed these trades go through was something called ‘phantom’ sales, the tool of naked short selling.

Phantom Sales?

The term “phantom sales” sounds even more nefarious than “naked shorts.” What it means, is that the naked short sellers deposited digital IOUs into buyers’ accounts, promising that they will locate shares and make good delivery to the buyer as soon as possible. Unfortunately, it can become impossible when more shares are sold than exist. That creates a failure to deliver or simply “FTD” which is used in a hashtag that most that follow AMC Theatres (AMC) are familiar with.

When a stock gets oversold to the point of more shares sold than exist, it can be very bullish for the holders. This is because the short sellers desperately need to make good on their IOUs held by buyers.

If buying demand picks up in the stocks, the short positions are considered to be getting “squeezed” –  a “short squeeze” is taking place.

In the case of GME, communication made better through social media channels and stock message boards allowed individual investors to loosely coordinate and heighten the squeeze on short sellers, including large institutional hedge funds that may have had naked short positions.

Naked Shorts Banned

Imagine the problems and stress that occurs when trades don’t settle on time due to naked short-selling delivery failures.

The SEC banned the practice of naked short-selling in the United States in 2008 after the financial crisis. The ban applies to naked shorting only and not to other short-selling activities. Prior to the ban, in 2007 the regulator amended a 2005 rule called Regulation SHO. The amendment limits possibilities for naked shorting by removing loopholes that existed for some broker-dealers in 2007. Regulation SHO requires lists to be published that track stocks with unusually high trends in failing to deliver (FTD) shares.

These lists are available to investors and often used to determine where activity may become frantic.

A variant that is not banned, or in violation of SEC is rules is an FTD where the shares were located, but there is a legitimate failure to deliver. That is the short seller contacted a holder (usually through a broker) and they both agreed to terms of the short-seller borrowing authentic shares of the company.

Take Away

Short selling is a normal function of trading and not frowned upon by the regulators. However you have to be in touch with shares that are available for you to borrow at an agreed-upon interest rate. Otherwise you may find you are naked selling because you don’t own the shares, and can not make delivery.  

These rules apply to stocks that trade on a national exchange. For those stocks not listed on a major securities exchange, the SEC may require more disclosure from the transacting broker.

Paul Hoffman

Managing Editor, Channelchek

Are Naked Shorts Depressing Your Investment Portfolio?

Posted on by phoffman@channelchek.com
Image Replicated from Twitter (1/23/2023)

Small-Cap Companies are Punching Back on Naked Shorts in Growing Numbers

The hashtag #NakedShorts has been trending on Twitter for over a week. To save Channelchek readers any embarrassment that may occur from Googling this term, especially at work, below are specifics on this market jargon. Also included below are specifics on why this has been trending and how it may impact self-directed retail traders and even small publicly traded companies that have the potential to be impacted by an illegal practice that apparently is not uncommon.

What are Naked Shorts?

Naked short selling of stocks is the illegal practice of short-selling shares that have not been allocated and verified to exist. Most shorting of stock occurs only after the trader borrows the security or determines that it can be borrowed before they sell it short (without owning). So naked shorting refers to short pressure on a stock that may actually be larger than the tradable shares in the market. This can place downward pressure on shares as they are sold, at times in excess of their existence.

Despite being made illegal after the 2008–09 financial crisis, naked shorting continues in practice because of loopholes in rules and discrepancies between physical and electronic trading systems.

Small Caps Revenge

Empowered by the activities of Gamestop (GME) and others, a growing number of small-cap companies are devising plans to go after naked short sellers.  This could help their companies trade at a fairer value rather than be artificially depressed by illegal trading practices.

Companies involved in heightening integrity in the markets for their stock are companies like Verb Technology Co. Inc. (VERB), a provider of interactive video-based sales apps with operations in Newport, California, and Lehi, Utah. Verb said this week it was joining education company Genius Group Ltd. (GNS), e-scooter and e-bike maker Helbiz (HLBZ), and Creatd Inc. (CRTD) designed for creators in coming up with measures to ensure “greater integrity in the capital markets” as Verb Chief Executive Rory J. Cutai said in a statement.

The move gained impetus last week as Genius Group said it had appointed a former F.B.I. director to lead a task force investigating alleged illegal trading in its stock, first disclosed a few weeks ago. Genius CEO believes there has been a measurable cost to the company. “We want this to stop,” he said. “They’re taking value away from our shareholders. They’re predators. They’re doing something illegal, and we want it to stop, whether that means getting regulators to enforce existing regulations or put new ones in place,” he said.

Legality of Naked Short Selling

In regular (legal) short trading, an investor borrows shares from someone else and pays an interest rate or “rebate rate.” They then sell them in anticipation of the stock price falling. The trade is a winner if the price falls and the seller buys them back at a lower price (netting out rebate rate) to close out the open short sale.

In naked short selling, investors don’t borrow the stock. They skip right to selling unowned with a promise to deliver them at a later date. If that promise is not fulfilled, it’s a failure to deliver.

Recently, companies such as AMC have paid a special dividend to determine, and frankly hurt, those short sellers that have not abided by the rules by first borrowing the security it sold.

Image: Elon Musk has been very vocal, Tesla is a company that hedge fund managers have routinely shorted (Twitter)

What Some Companies are Doing

Last week Helbiz said it was going to punch back at naked short positions. Creatd CEO Jeremy Frommer, meanwhile, is behind Ceobloc, a website that aims to end the practice of naked short selling. “Illegal naked short selling is the biggest risk to the health of today’s public markets” is how the site introduces its mission.

Genius just set guidance for 2023, saying it expects revenue of $48 million to $52 million, up 37% from its 2022 pro forma guidance. Last Thursday, the stock rose a record 290% in volume of about 270 million shares traded. That crushed the daily average of about 634,000. The CEO says this is another indicator of wrongdoing, given that the company’s float is just 10.9 million shares. “Clearly, that’s far more shares than we created,” the founder, Roger Hamilton points out.

Take Away

It is unclear what the task force of the small-cap companies intends to do. Companies like AMC Theaters (AMC) waged war by declaring a dividend that was a different class of stock. Shareholders would have to verify their ownership of a registered share in order to receive the dividend. This went a long way to verify what is in the float that is legitimate and that which is not.

Paul Hoffman

Managing Editor, Channelchek

Sources

https://www.marketwatch.com/story/small-cap-companies-are-going-after-naked-short-sellers-in-growing-numbers-its-the-biggest-risk-to-the-health-of-todays-public-markets-11674480805?mod=newsviewer_click

https://www.investopedia.com/terms/n/nakedshorting.asp