Traders work on the NYSE floor.
Short sellers on the ropes – or do they?
Short sellers clearly chose the wrong names in January. The GameStop phenomenon, in which buyers target sharply shortened stocks, is just the latest in a long line of short-selling failures. But don’t count them out.
Most short sellers lose money
The relentless rally in the market has not been good for short sellers in many years. For all the attention paid to superstar short sellers, most of these managers are losing money. Stock short positions lost $ 243 billion in 2020, a return of minus 26%, according to S3 Partners.
This month her performance is even worse. In January alone, they fell by $ 91 billion, according to S3.
And while traders often focus on stocks that short sellers made money because they were in unfavorable sectors (ExxonMobil) or had accounting irregularities (Luckin Coffee and Wirecard), most shorts are unsuccessful.
In 2020, 57% of all stocks cut money lost. Sixty-eight percent of every dollar bet lost money.
“Short-sellers’ biggest enemy wasn’t Robinhood or Reddit chat rooms, it was the Federal Reserve and the impetus that got most stocks up. It’s not a values market, it’s a momentum market, and they are [short sellers] are on the wrong side of the dynamic, “said Ihor Dusaniwsky of S3 Partners.
With short sellers hitting the ball, it’s no surprise that the dollar value of stocks slumped against the dollar value of the S&P 500 is at its lowest level in several years, according to Goldman Sachs.
Shorts aren’t a big part of the market
At any point in time, Dusaniwsky says short sellers typically have $ 900 to $ 1.3 trillion of empty bets in the market. That’s roughly 2% to 3% of the market capitalization of US stocks.
This may seem like a small amount of money, but short sellers play a very important role. You are instrumental in bringing up companies with potentially questionable accounting, as was the case with Luckin Coffee and Wirecard last year.
They also offer protection for long portfolios.
Your most important function can be as a liquidity provider. They provide liquidity to the stock market and they provide liquidity to derivatives traders who take the other side of options trading.
This is where the GameStop story comes in. “Shorts provide liquidity at the back end of rallies. If you’re a long seller at the high end of a rally, the shorts are the only ones buying your stocks,” Dusanivsky said. “The shorts offer liquidity that many longs no longer offer.”
The end of the shorts? By far not
Shorts certainly seem to be in a difficult position. Academy Securities’ Peter Tchir said that shorts are being hit with a “double blow”: first the inexorable surge in the market, then “some traders are aggressively buying call options out of the money. That pulls the shorts right now, it seems like an effective strategy . “
What will happen to the shorts? “Shorts need to be more comfortable with losses before they are stopped,” Tchir said. “And I would guess that call option prices will go up. Moves like [Monday] seem insane without reevaluating the options. It makes me nervous. “
If the prices of call options do indeed rise, warns Tchir, it could create false signals for the market. “If call option prices rise, it could drive the VIX higher and traders may mistakenly believe that fear is building. It may not be the time to be bearish, but it is certainly the time to be highly volatile stocks avoid chat room favorites. “
Despite all the difficulties, Dusanivsky laughs when I ask if this is a fatal blow to short sellers.
Not a chance, he said: “Even if the shorts are killed, new shorts will be added, especially in finance and even in the names that have had the greatest success in blowing shorts.”
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