To paraphrase Mark Twain, the reports of the death of short sellers have been greatly exaggerated. Looking at Short Interest as a % of Float, we do see a significant decrease in shares shorted, but just counting the total amount of physical shares shorted does not give a complete picture of short selling and short exposure. We need to look at Short Interest, or dollars at risk, to truly see what the shorts are doing.
Total shares shorted, as represented by S3 SI% Float and original SI % Float show a -7% decrease in shares shorted in the 3rd quarter. S3 SI % Float differs by SI Float by taking into account the “synthetic longs” created by short selling which are tradable securities that increase overall tradable liquidity in a security.
The decrease in shares shorted has increased stock lending supply in many securities and has been the primary driver to the easing in stock loan fees. Over the 3rd quarter average stock lending fees fell by almost a third, from 1.27% fee to 0.87% fee. The biggest drop occurred in the Industrial and Consumer Discretionary sectors with stocks such as Carnival (CCL), Workhorse Group (WKHS), Macy’s (M), GSX Techedu (GSX) Nikola (NKLA), Deutsche Lufthanza (LHA GR) and Virgin Galactic (SPCE) having the largest effect on the weighted average rate decline.
Overall, worldwide short interest declined by only -1.55% in the third quarter with the largest declines in the Energy, Real Estate and Consumer Staples sectors. On the other side of the coin, the largest increases in short interest were in the Consumer Discretionary and Information Technology sectors.
The reason why there is such a disparity between the change in SI % of Float and Short Interest is that there was a mark-to-market offset to short covering. Traders were delta hedging their short exposure, selling shares as stock prices rose in order to keep their dollar exposure relatively flat. The $148 billion of short covering was partially offset by $124 billion of mark-to-market increases in notional positions.
It is fitting to close with another quote from Mark Twain, “There are lies, damned lies and statistics”. By using the incorrect metric or ignoring relevant ones we can see where the narrative of short sellers exiting the market was an easy and popular story line. But in actuality, as the markets rose, short sellers were forced to sell shares in order to keep their short exposure at levels they were comfortable with. Much like blackjack player on a roll, as their chip stacks get higher the dealer starts replacing lower denomination chips with higher denomination chips and although the gambler may be betting fewer chips in every hand, the dollar value of their overall bet remains flat. There may be less shares shorted in the market, but the overall value of short exposure in the market has remained relatively stable.
That is not to say that we will not see a trend of short covering in the near future as mark-to-market losses continue to mount. Short sellers were down -$121 billion in mark-to-market losses for the quarter. The largest overall losses occurred in the Consumer Discretionary and materials sectors while the only winning sectors on the short side were the Energy and Real Estate sectors.
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The information herein (some of which has been obtained from third party sources without verification) is believed by S3 Partners, LLC (“S3 Partners”) to be reliable and accurate. Neither S3 Partners nor any of its affiliates makes any representation as to the accuracy or completeness of the information herein or accepts liability arising from its use. Prior to making any decisions based on the information herein, you should determine, without reliance upon S3 Partners, the economic risks, and merits, as well as the legal, tax, accounting, and investment consequences, of such decisions.