Please explain "short squeeze" (out of main)

[EV forever]

Can someone take a few moments to explain this short squeeze concept to an ignorant like me, in plain common English please? I had never heard the term till the now infamous tweets last year from Elon. In fact, had never heard the term 'Shorting a stock' till I started following TSLA in 2014. So, this has been educational for me so far!

I understand that short squeeze would occur when the folks who have shorted the stock are "forced to cover" and this depends on each individual account, stock broker, cash levels in account and relationship with the stock broker.
So, say I was a retail investor who shorted 100 shares of Tesla at a price of $300. My stock broker is JP Morgan, I have good relationship with no other risky bets, have other safe investments worth $100,000.

1. At what point would I be forced to cover?
2. How much cash would I need to add to the account to avoid having to cover?

Edit - if this has been already discussed before, just point me to the correct place

 

[MP3Mike]

Can someone take a few moments to explain this short squeeze concept to an ignorant like me, in plain common English please? I had never heard the term till the now infamous tweets last year from Elon. In fact, had never heard the term 'Shorting a stock' till I started following TSLA in 2014. So, this has been educational for me so far!

I understand that short squeeze would occur when the folks who have shorted the stock are "forced to cover" and this depends on each individual account, stock broker, cash levels in account and relationship with the stock broker.
So, say I was a retail investor who shorted 100 shares of Tesla at a price of $300. My stock broker is JP Morgan, I have good relationship with no other risky bets, have other safe investments worth $100,000.

1. At what point would I be forced to cover?
2. How much cash would I need to add to the account to avoid having to cover?

You can read some basic items on margin requirements here: What Are the Minimum Margin Requirements for a Short Sale Account?

But as an example if you were at the margin requirements at close on Friday you would currently need to add ~$3,000 to prevent covering from the ~$22 increase today. (Assuming a margin requirement of 25% which is the minimum allowed and your broker can set it much higher.) So you would have a minimum of ~$48k in cash tied up in your short position. (With only $30k of that provided by the original shorting transaction.)

 

[SoGA Fan Club]

Can someone take a few moments to explain this short squeeze concept to an ignorant like me, in plain common English please? I had never heard the term till the now infamous tweets last year from Elon. In fact, had never heard the term 'Shorting a stock' till I started following TSLA in 2014. So, this has been educational for me so far!

I understand that short squeeze would occur when the folks who have shorted the stock are "forced to cover" and this depends on each individual account, stock broker, cash levels in account and relationship with the stock broker.
So, say I was a retail investor who shorted 100 shares of Tesla at a price of $300. My stock broker is JP Morgan, I have good relationship with no other risky bets, have other safe investments worth $100,000.

1. At what point would I be forced to cover?
2. How much cash would I need to add to the account to avoid having to cover?

Edit - if this has been already discussed before, just point me to the correct place

EDIT: I corrected some mistakes. So re-read if you have already read it.

So, here's the way I try to think about margins and squeezes. Your broker loans you 100 shares that you will sell at the current price because you believe the SP will go down. You get the proceeds from the sale of the shares. They want you to have enough money in your account at all times for them to be able to buy back the shares you borrowed from them. However, since they are smart enough to know there will be days like today and the day earnings were released, they not only want you to keep enough in your account to be able to buy the shares back TODAY, but also a nice buffer in there in case of a big run-up. Typically, I think this number is like 25%.

So let's say you shorted 100 shares at $100. You would need to have $10,000 dollars (you got this from selling the shares) + $2500 ($12,500) in your account to do the transaction. If the stock goes down in price, obviously, you will hear nothing from your broker. However, if the price goes up, you no longer have a 25% cushion. So, if the price moves up to $110, you need to have $11,000 + $2750 ($13,750) in your account. They will send you a margin call for $1250 - if you don't deposit it, they will use the money in your account to buy the shares that you owe them. Whatever is left in the account is obviously yours.

Now, you can see from this where, if you made a bad bet, you better have deep pockets to keep your margin satisfied (not just the margin, but the cost of the higher priced shares). That is where the short squeeze often gets started. Obviously, when a stock moves up quickly as TSLA has over the last couple months, it requires short sellers to constantly increase the money in their account to cover the buyback (+25% margin). At some point, for a lot of people, they either don't have any more money to put in their account, or they just give up. So, they close out their short position (buy back the shares at the higher price). This creates demand for the stock, and in theory, will make the price go higher, which will in turn put MORE pressure on other shorts. Every time the stock moves up, it is "squeezing" SOMEBODY out. And that person (I'm saying person to keep it simple) causes the price to go higher and squeezes more out.

It basically becomes like an Avalanche - once the squeeze starts, it just starts gathering steam, the more steam it gets, the faster the stock rises and the more steam it gathers (because it will collect more and more shorts).

The problem with this theory for TSLA is that this stock, and its short sellers are like NONE I have ever seen. They are not betting against TSLA based on fundamentals or technicals - nope, this is an emotional thing for them now. It is to the point of war. They would rather their kids go hungry and live under a bridge than lose this war against Elon Musk. They will hold on as long as they can find the money to cover their margin calls. I believe it would take $1000 to $1200 SP to trigger a squeeze. One can only hope!

 

[SageBrush]

While the above explanations are spot on, a really nasty short squeeze occurs when shorts have to bid against each other to exit, meaning there is more demand to buy than stocks up for sale.

About 20% of Tesla outstanding shares are shorted and ~ 3% of shares change hands daily. My WAG is that if a day occurs where 10% of shorts want to close their position -- watch out and hold on tight !

This account of the VW short squeeze 'burn of the century' is an excellent read.

 

[ggr]

Mod: moved these posts to a thread of their own to make it easier for people to search for them. --ggr

The important thing to remember about a short squeeze, as was mentioned above, is that there can be a positive feedback loop. As the value of your short investment falls, there will come a time when you have no alternative but to reduce your exposure by covering, but that means you have to buy stock, but there aren't very many people wanting to sell... so that forces the price higher again.

The same thing can happen with long holdings on margin when the stock is falling. When you buy stock on margin, you are essentially taking a loan from the broker to buy the stock, guaranteed by the value of the stock. When the stock goes down, the broker will require you to somehow get cash into your account, by sending them money, selling other stock, or selling the stock in question. What's worse is that they might suddenly decide that the stock is a bad security or too volatile, so they will increase the margin maintenance percentage on that particular stock. Now, you suddenly need much more cash to cover your debt to the broker.

There are three reasons the margin maintenance requirement can be raised.
1. The stock is dropping, so the broker thinks it is unsafe to back your loan with it. This only happens in a falling stock.
2. The stock is moving fast in either direction (volatility) so the broker is afraid that investors will be caught one way or the other.
3. (This is probably about to happen to me again!) The value of a particular stock in your portfolio exceeds 80%, they get worried that you won't be able to take a sudden drop. Note that this will force you to sell stock at exactly the time you want to be holding it.

Anyway, back to the short squeeze. There is one major difference between the shorts in a rising stock, and margin calls on a long position in a falling stock. That is that the loss on a long position is limited to whatever you invested, and a margin call can only be a percentage of that. So you invested 100@$300 in TSLA on margin (25%MMR), that used up $7,500 of your cash. TSLA goes down to zero, you have to pay the rest of the loss, $22,500. This may happen in lots of little margin calls on the way down, but that is the absolute worst case, ignoring the interest you paid on the loan in the meantime.

But in the short scenario (as mentioned above), you needed $7500 in your account to do the trade, and now all of that cash ($37500) is locked up. TSLA goes to $600 overnight (same number of dollars movement, just in the other direction), now it costs you $60,000 to cover, but unlocks your spare $7500, so you have lost the same number of dollars, again ignoring interest. Here's the difference: TSLA is limited to zero in the long case, but it isn't limited on the upside at all. ARK has a price target of $4000. If TSLA suddenly went to that, before you got a chance to cover, it would cost you 100*$3700, $370,000! You started with $7500. Of course the broker would have made you cover multiple times in that period, but since they are on the hook if you go broke, they can be pretty merciless.

The usually quoted example is when Porsche locked up virtually all of VW's stock some years back, and when the dust settled the companies merged with Porsche owning a very large chunk of VW. A lesser known example is Qualcomm (QCOM) at the end of 1999,

At the time QCOM was the TSLA in terms of short interest percentage. The turning point was a lawsuit that said that 3G cellphones did indeed need CDMA licenses from Qualcomm, and then in May QCOM was added to the S&P500 (If I am recalling correctly. I was an employee at the time).

 

[EV forever]

Thank you very much for all the explanations - it is clearer now. Also thanks for moving the question to a new thread - much easier to follow the answers!
I am guessing we are not yet in the region of a nasty short squeeze as SageBrush describes in #4 above. Also, I agree with SoGA Fan Club in post #3 - the folks like the ones on $TSLAQ are clearly beyond all rational arguments - they are entirely in this emotionally. So they will hold on with every last penny they have, which means the nasty short squeeze will not occur till we are well above the current price - maybe when Tesla gets listed on S&P500 as in the QCOM story #5.

But something that ggr said in the post above bring me to one more question -

But in the short scenario (as mentioned above), you needed $7500 in your account to do the trade, and now all of that cash ($37500) is locked up. TSLA goes to $600 overnight (same number of dollars movement, just in the other direction), now it costs you $60,000 to cover, but unlocks your spare $7500, so you have lost the same number of dollars, again ignoring interest. Here's the difference: TSLA is limited to zero in the long case, but it isn't limited on the upside at all. ARK has a price target of $4000. If TSLA suddenly went to that, before you got a chance to cover, it would cost you 100*$3700, $370,000! You started with $7500. Of course the broker would have made you cover multiple times in that period, but since they are on the hook if you go broke, they can be pretty merciless.

So how much cash is required in a margin account to initiate this short trade? Is it only $7500 for my hypothetical scenario of shorting 100@300 or is it 37,500? If the former is the case, this is ridiculous how little money is required to play this game - pretty much like gambling.

100@300 = $30,000 + $7500 Starting point. Does the short seller need to pay the entire $37,500 or just $7500?

If stock goes up to $600 = $60,000 + $15,000; so broker will want the short seller to add $37,500 to the account to ensure there is money to cover, correct?

So with the current run up to ~ $380, the broker would want the short seller to add $10,000 to avoid being forced to cover.

If this is correct, then I understand the short squeeze is not quite here yet - the shorts are too emotionally vested to give up and probably have the means to hold for now.

 

[bhtooefr]

It is also worth noting that a Volkswagen-style short squeeze involves a "corner" - that is, a party working to secure all of the outstanding shares specifically to burn the shorts - which is nearly impossible to pull off in the US due to ownership reporting requirements.

There's a short time limit (four days? Or am I thinking of insider reporting?) for a party buying more than 5% of the float to file a report with the SEC, IIRC, which prevents them from slowly accumulating a huge percentage of the float unnoticed. (I think this might apply to derivatives, too? That would prevent doing it through slowly accumulating a crapton of call options and then suddenly exercising them, too...) If they try to buy it up quickly, that'll drive up the price on their massive buying pressure, limiting the impact of the short squeeze.

All of this means that in the US, it's much easier for shorts to exit in a more orderly fashion.

(Of course, there are still ways to do corners in the US in extremely highly-shorted stocks - I've heard on this forum of cases of penny stocks where someone buys over 100% of the float in a single relatively small transaction, and then revealed their position. Tesla's a bit too big to do that.)

 

[SageBrush]

If stock goes up to $600 = $60,000 + $15,000; so broker will want the short seller to add $37,500 to the account to ensure there is money to cover, correct?

Yes. The short already has $37,500 of cash tied up in the form of $30,000 he received from the short transaction and $7,500 of his own cash he placed in reserve to be able to short in the first place.

The new cash reserve after the stock climb to $600 is $600 * 100 shares * 1.25 = $75,000 so the broker demand for new cash will be 75,000 - 37,500

---
So far as I know this is just the cash requirement required of all short transactions. I don't know broker requirements if the cash is borrowed from the broker. Even if it is the same, the broker is forcing the short to pay interest fees on a forced loan. And then there is the fee that the short pays the broker to borrow the stocks in the first place. It adds up pretty quickly.

 

[davepsilon]

A short squeeze is generally when short positions are closing at enough volume to significantly move the price and this price move convinces other shorts to close as well. This is a feedback loop of technical demand that can run the price of a stock up quite high, but the highest prices are usually temporarily. It's only one form of technical demand which is demand for the stock for reasons other than the fundamental value from future cash flows. Being added to the S&P for instance would create boatloads of technical demand as index tracking funds would need to buy.

 

[SageBrush]

It's only one form of technical demand which is demand for the stock for reasons other than the fundamental value from future cash flows. Being added to the S&P for instance would create boatloads of technical demand as index tracking funds would need to buy.

Since OP is interested in short squeeze, I'll ask here about the S&P: Do I understand correctly that 4 consecutive profitable quarters are a pre-requisite for S&P inclusion ?

 

[davepsilon]

Since OP is interested in short squeeze, I'll ask here about the S&P: Do I understand correctly that 4 consecutive profitable quarters are a pre-requisite for S&P inclusion ?

Well, no that's not exactly true. There is a set of standard requirements and that is one of them but any addition is at the discretion of the 9 member index committee who by simple majority could make an exception. S&P inclusion or lack of has been discussed at length here Shall TSLA be added to S&P500? (out of main)

 

[MP3Mike]

Since OP is interested in short squeeze, I'll ask here about the S&P: Do I understand correctly that 4 consecutive profitable quarters are a pre-requisite for S&P inclusion ?

There is a set of standard requirements and that is one of them

Actually that isn't one of them. The criteria is that the last 4 quarters sum to a profit. Not that all 4 quarters individually need to have profit.

 

[SageBrush]

^^ The earlier discussion was informative -- thanks for the link.
If I'm following correctly, the S&P inclusion committee have guidelines. The stronger the company sheet, the more likely inclusion occurs. GAAP+ over the last averaged 4 quarters and profit positive in the latest quarter for a big cap company is a fair candidate.

If Tesla decides to play the S&P inclusion game then perhaps after Q1/2020 since I doubt they can turn 2019 GAAP positive. Possible, but they would have to declare close to $1B GAAP in Q4/2019