Few things are as infuriating — or dangerous — as a short squeeze.
There is this preposterous stock, I won’t mention any names, at 90, up from 70 up from 30 up from 8, and it’s just such an obvious short. It has no sales, no earnings, the boss has disappeared or turned out to have a criminal record — and still the stock goes up.
If it sounds impossible, you’ve never observed, let alone been caught in, a short squeeze.
Who’s buying at these prices? You marvel.
Four kinds of people:
- Scared short-sellers who’ve already lost so much they just can’t stand one more sleepless night, so they buy shares to cover their short. I know a guy who lost $19 million this way.
- Short-sellers who have no choice. The equity in their accounts has put them below margin requirements, so they must cover some of the short, like it or not.
- Short-sellers who are forced to cover when the lending broker recalls the shares and no other shares can be found to borrow. (Sometimes participants in a short squeeze will even instruct their brokers to switch shares from their margin to their cash accounts in order to tighten the squeeze and drive the price higher. Stock in a cash account cannot be loaned out.)
- Speculators who sniff blood. They know the stock is a complete piece of junk but gamble that the bubble won’t burst for another 30 or 40 points. If they buy enough, their own buying may drive up the price, forcing more short-sellers to buy also — to stem their losses or meet margin calls — driving the price higher still.
As a rule of thumb, a good time to short a stock is when you can’t. No more shares are available to borrow.
But even if you could, shorting is not for the faint of heart or inexperienced. Puts are safer but will be priced very high in a short squeeze (because put-sellers realize the stock could drop like a stone at any instant). And synthetic shorts — writing a call and simultaneously buying a put, which gets around the unavailability of stock to borrow — is both expensive and risky.
There’s nothing un-American about shorting stocks, but there’s lots about it that, for all but a few, makes it inadvisable.