Traders work on the NYSE floor.
NYSE
Short sellers on the ropes – or are they? Short sellers clearly chose the wrong names in January. The GameStop phenomenon – where buyers deliberately target heavily sold stocks – is just the latest development in a long series of short sellers failures. But don’t delete them yet.
Most short sellers lose money
The relentless rally in the markets has not been good for short sellers for many years. Despite all the attention that superstar short sellers are given, most of these managers lose money. Short positions in shares lost $ 243 billion in 2020, a negative return of 26%, according to S3 Partners.
This month, their performance is even worse. In January alone, they fell $ 91 billion, according to S3.
And although traders often focus on stocks that have made money for short sellers because they are in disadvantaged sectors (ExxonMobil) or with accounting irregularities (Luckin Coffee and Wirecard), most sellers are unsuccessful.
In 2020, 57% of all securities sold lost money. Sixty-eight percent of every dollar wagered lost money.
“The biggest enemy of short sellers was not Robinhood or Reddit’s chat rooms, but the Federal Reserve and the stimulus, which pushed most stocks up. It is not a value market, it is a market for impulse, and they [short sellers] are on the wrong side of the moment, “Ihor Dusaniwsky of S3 Partners told me.
Given the defeat that short sellers have suffered, it is not surprising that the dollar value of shares sold short compared to the dollar value of the S&P 500 is at its lowest level in several years, according to Goldman Sachs .
Shorts are not a big part of the market
At any time, short sellers typically have $ 900 billion to $ 1.3 trillion in short bets on the market, according to Dusaniwsky. This is about 2% to 3% of the US stock market capitalization.
This may seem like a small amount of money, but short sellers play a very important role. They are instrumental in attracting the attention of companies that may have questionable accounting, as was the case with Luckin Coffee and Wirecard last year.
They also provide hedging for long portfolios.
Their most important role may be that of liquidity providers. They provide liquidity to the stock market and provide liquidity to derivatives traders who take the other side of options trading.
That’s where the GameStop story comes in. “Short selling provides liquidity at the end of highs. If you are a long seller at the top of a high, short selling is the only one that buys your shares,” said Dusaniwsky. “Short positions provide liquidity that many positions no longer offer.”
The end of the shorts? Not for a long shot
The shorts certainly seem to be in a difficult position. Academy Securities’ Peter Tchir said that short positions are being hit by a “double hit”: first, the relentless increase in the market, but then “Some traders are aggressively buying money options. This tightens short positions. moment seems to be an effective strategy. “
What will happen to the shorts? “The shorts are going to have to feel more comfortable with the defeats before they are stopped,” said Tchir. “And I imagine that the prices of the call options will go up. Movements like [Monday] it seems insane without a repricing of options. It makes me nervous. “
If call option prices do go up, Tchir warns that this could generate false signals for the market. “If the price of call options goes up, it could force the VIX to go up, and traders may mistakenly believe that fear is building up. It may not be the time to fall, but it certainly can be the time to avoid highly volatile stocks that are favorites from the chat room. “
Despite all the difficulties, Dusaniwsky laughs when I ask if this is a death blow to short sellers.
Without a chance, he told me: “Even while shorts are dying, new shorts are emerging, mainly in the financial sector and even in the names that have had the most success in destroying short sellers.”
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