While not all stocks with high borrow rates correlate with eventual short squeezes, looking at the pool of stocks with sudden and significantÂ increases in their financing costs is a target rich environment for finding stocks with short squeeze potential. An unanticipated and hefty increase in a short stockâ€™s borrow fee can pressure short sellers to close out their positions as financing costs take out an outsized portion of their expected Alpha.
Stock Borrow Fee: The annualized stock borrow fee charged by brokers to short sellers. Short sellers pay a fee to borrow stock to cover the settlement of their short sales. The daily cost to borrow stock is the $ Notional of the short position * Stock Borrow Fee / 360 days. Stock loan is a supply\demand market, if supply gets tight or demand spikes borrow fees are bound to go up.
The U.S. traded stocks with the largest weekly increase in stock borrow fees (minimum short interest $100 mm):
The stocks in the chart above had the largest two week increase in stock borrow rates and all of them had increases in todayâ€™s â€śspotâ€ť borrow rates which gives us a â€śdirectional arrowâ€ť of future rate changes. If stock borrow rates have already risen significantly, and the borrow is getting more expensive, shorts may begin to rethink their short selling thesis.
Not only does this more expensive stock borrow cost decrease net-of-financing Alpha it also implies a decline in lendable stock in the name which increases the chance of recalls if long-lending beneficial owners sell their shares. Even if recalls do not materialize, there is a strong prospect that short locates will be more difficult to secure, which will limit future short selling and minimize the downward price effect of systemic selling pressure.
While a short squeeze in already expensive rate-rising stocks is not guaranteed, there is a strong chance that short selling pressure will subside and long shareholders will once again control the destiny of the price action of their shares. If longs begin to sell, shorts may ride along, even if it is more expensive to do so, and force the stockâ€™s price down even further. If long shareholders begin to buy into the stockâ€™s price weakness, there is a greater chance that the short sellers in these rate-rising stocks turn tail and head for the hills.
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Managing Director Predictive Analytics, S3 Partners, LLC
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