Short sellers fell $ 91 billion in January as GameStop led to declining stocks

Short sellers on ropes – or are they? Clearly, short sellers chose the wrong names in January. The GameStop phenomenon – where buyers deliberately target heavily shortened stocks – is just the latest development in a long line of failures from missing sellers. But don’t count them yet.

The tireless market rally has not been kind to short sellers for many years. Despite the attention paid to superstar short sellers, most of these managers lose money. Capital shorts 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 by $ 91 billion, according to S3.

And while traders often focus on stocks that have made money for short sellers because they are in sectors that were wrong (ExxonMobil) or had accounting irregularities (Luckin Coffee and Wirecard), most shorts fail.

In 2020, 57% of all securities lost money. Sixty-eight percent of every dollar bet lost money.

“The biggest enemy of short sellers was not the Robinhood or Reddit chat rooms, it was the Federal Reserve and the incentive that pushed most of the above actions. It is not a value market, it is an impulse market as well [short sellers] I’m on the wrong side of the momentum, “Ihor Dusaniwsky of S3 Partners told me.

Given short-selling sellers, it’s no surprise that the dollar value of shortened stocks compared to the dollar value of the S&P 500 is at its lowest level in years, according to Goldman Sachs.

At any given time, missing sellers typically have $ 900 billion to $ 1.3 trillion in short bets on the market, according to Dusaniwsky. This represents about 2% to 3% of the market capitalization of US stocks.

This may seem like a small amount of money, but sellers soon play a very important role. These are essential in appealing to companies that may have questionable accounting, as was the case with Luckin Coffee and Wirecard last year.

It also ensures the coverage of long portfolios.

Their most important function may be liquidity providers. They provide liquidity for the capital market and provide liquidity for derivative traders who take the other side of option transactions.

This is where the GameStop story comes into play. “Shorts provide liquidity in the back of rallies. If you are a long seller at the end of a rally, shorts are the only ones that buy your shares,” Dusaniwsky told me. “Shorts offer liquidity that many long ones no longer offer.”

Certainly, shorts seem to be in a difficult position. Peter Tchir of the Securities Academy said the shorts are hit with a “one-two punch”: first, the relentless growth of the market, but then “Some traders buy aggressively from money call options. at the moment it seems to be an effective strategy. “

What will happen to the shorts? “Shorts will have to be more comfortable with losses before they are stopped,” Tchir told me. “And I would assume that the prices for the call options will increase. Movements like [Monday] they seem crazy without a reassessment of options. It makes me nervous. “

If call options prices really rise, Tchir warns that it could generate false signals to the market. “If the prices of call options increase, this could force the rise of VIX, and traders may mistakenly believe that fear is forming. It may not be time to cut back, but it certainly can be the time to avoid the highly volatile stocks that are the chat room favorites. “

Despite all the difficulties, Dusaniwsky laughs when asked if this is a deadly blow to short sellers.

It’s not a chance, he told me: “Even while the shorts are being killed, new shorts are appearing, especially in the financial field and even in the names that have had the greatest success throwing in sellers in a short time.”

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