What is Short Selling?

When an investor or institution wants to bet on a stock price falling they can open a ‘short position’ in the stock by selling stock they do not currently own and then buying it back at a later date at a lower price. 

How to Short-Sell a Stock

When an investor wishes to sell a stock short (also termed ‘opening a short position’) they will first need to locate and arrange to borrow the stock from someone who owns it. The typical method for doing this is firstly to request the broker locate and arrange to borrow the stock (usually for a fee) prior to executing the sell order. 
Upon executing the sell order the broker will then finalize the loan of the stock, which will need to be delivered when the trade settles in two days. In the event the loan of the stock is not successfully completed the trade will fail and be unwound. 

What is Short Interest Data?

When a broker-dealer has a short position in a stock they are required to report this twice per month. This data is then aggregated and the short interest (ie the total of all short positions) is calculated. The short interest is reported as the total number of shares that are short-sold. 

How to Use Short-Interest Data?

Short positions in stocks are typically more risky than long positions. A short position can expose the investor to a theoretically unlimited loss. Therefore, strict loss-limiting orders are typically put in place when the short position is created. These orders are buy orders which are only triggered when the stock increases to a specified level. 
Thus, a large short-interest position in a stock suggests there is an accumulation of large buy orders that can be triggered when a stock price rises. Therefore a rise in the stock price can trigger a ‘short-squeeze’ which forces a short-covering stock rally as short-interest holders are forced to purchase the stock. 

This information can be very useful in positioning, especially for options, as a large short-interest position indicate an asymmetry in the stock’s potential returns which option prices may account for - in such a scenario the call options will underestimate the probability of the stock spiking and the options may be underpriced. 

Days To Cover Ratio

In assessing the possibility of a short squeeze generating a price spike, it is essential to understand the magnitude of the short interest relative to the liquidity of the stock. The most common metric used to evaluate this is the ‘days to cover’ ratio. This is the number of days volume the short-interest represents, so a stock that has an average daily volume of 1000 shares and has short interest of 3500 shares would have a days-to-cover ratio of 3.5. 

We have recently introduced historical short-interest data on listed tickers to our Stocks Complete dataset.