Traders work on the floor of the NYSE.
NYSE
Short sellers on the ropes – or is it? Short sellers clearly chose the wrong names in January. The GameStop phenomenon – where buyers deliberately target heavily shorted stocks – is only the most recent development in a long line of short-selling failures. But do not count it out yet.
Most short sellers lose money
The market’s relentless rally has not been good for short sellers for years. All the attention paid to superstar short sellers, most of these drivers lose money. Equity shorts lost $ 243 billion in 2020, a return of negative 26%, according to S3 Partners.
This month, their performance is even worse. In January alone, it was down $ 91 billion, according to S3.
And while traders often focus on stocks that make money for short sellers because they were in sectors that were out of favor (ExxonMobil) or had accounting irregularities (Luckin Coffee and Wirecard), most shorts fail.
In 2020, 57% of all securities lost money. Sixty-eight percent of every dollar bet lost money.
“The biggest enemy of short sellers was not Robinhood or Reddit chat rooms, it was the Federal Reserve and stimulus that pushed most stocks higher. It’s not a value market, it’s a momentum market, and they [short sellers] is on the wrong side of the momentum, ”Ihor Dusaniwsky of S3 Partners told me.
Given the beating short sellers are taking, it is not surprising, according to Goldman Sachs, that the dollar value of shares that are short compared to the dollar value of the S&P 500 is at its lowest level.
Shorts are not a big part of the market
According to Dusaniwsky, short sellers typically have between $ 900 and $ 1.3 billion in short games. This is about 2 to 3% of the market capitalization of US equities.
It may seem like a small amount of money, but short sellers play a very important role. They are instrumental in calling out companies with questionable accounting, as was the case with Luckin Coffee and Wirecard last year.
They also offer hedges to long portfolios.
Their most important function may be as liquidity providers. They provide liquidity for the stock market, and they provide liquidity for derivatives traders who trade the other side of options.
This is where the GameStop story appears. ‘Shorts offer liquidity at the back of rallies. “If you’re a long seller at the top of a rally, shorts are the only thing that buys your stock, ” Dusaniwsky told me. “The shorts offer liquidity that a lot of longing no longer offers.”
The end of a pair of shorts? Not long
Shorts definitely look in a difficult position. Peter Tchir of Academy Securities said shorts get a “one-two-stroke”: first the relentless rise in the market, but then: “Some traders aggressively buy from the money-calling options. It pinches the shorts. For the it seems a to be an effective strategy. ‘
What will become of the shorts? “Shorts will have to be more comfortable with losses before being stopped,” Tchir told me. “And I would guess that the prices for call options will go up. Movements like [Monday] seems insane without recalculating the options. It makes me nervous. ‘
If the call option prices are indeed rising, Tchir warns that it could generate false signals to the market. “If the option price rises, it could raise the VIX, and traders may mistakenly believe that there is a fear of building up. It may not be the time to be clumsy, but it’s definitely the time to avoid highly volatile stocks. chat room favorites. “
Despite all the trouble, Dusaniwsky laughs when I ask if it’s a killer blow to short sellers.
Not a chance, he told me: ‘Even though the shorts are being killed, there are new shorts coming in, especially in finance and even in the names that the shortest sellers have been successful at.’
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