ValueAnalyst
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I apologize in advance for the length
I would expect that in a short squeeze, we will see the interest rate Fidelity is charging to short sellers to increase. This is one lever Fidelity (and all other brokerages) have to decrease the number of shares lent out, and thereby manage their own exposure and risk. That interest rate may go up a lot, fast, depending on the severity of the short squeeze.
Of course I could be wrong about that - a fast rise in the share price could lead to shorts buying to close at a fast pace to get out, with the net result being lots of shares available for short sale, and little appetite for doing so. My thinking for making that prediction (rising interest rates to borrow), is that in a short squeeze, shorts are struggling to find shares they can buy to close their position. More broadly, the total number of shares beneficially owned are being shrunk as the shorts close their positions, making it harder to find shares, and thus the loop. Fidelity can manage that, to some degree, and mitigate risk as well, by increasing the rate they charge - weaker shorts will be driven out by the higher rates, and stronger shorts will pay more on a daily basis to maintain their position (thereby lowering the brokerage's risk).
I would expect to see supply of shares to be borrowed to increase, with our indicator being first that Fidelity is borrowing shares through their FPLP (Fully Paid Lending Program). With the recent program change, the rate paid by Fidelity is 60% of the rate Fidelity charges short sellers, so there are no longer any tea leaves to read between the 2 rates. Now the only thing to know is that shares are being borrowed from FPLP participants or not (my shares haven't been borrowed in close to 2 months - I miss the days of earning a little or a lot for shares I can reasonably expect to still own 10 years from now).
I recognize increasing supply is counter-intuitive. A more accurate statement would be to see an increase in RELATIVE supply, where the rate charged to borrow shares is an indicator of the current balance between supply of shares to short sell, and demand for shares to short sell. Even if the absolute supply is shrinking.
I view a short squeeze as an extreme imbalance between a bunch of market factors, not all of them directly or exclusively having to do with short sellers. One of them being the number of shares in the float that are reasonably easy to trade - a large number of strong longs entering the market will tend to shrink the float, and that reduces the ability of any particular short sale to be closed.
Incidentally, if we see decreases in the total number of shares short in the twice monthly report, while rates stay low, that indicates to me that the aggregate short position is being unwound in a stable and rational fashion. That's an indicator that we won't be seeing a short squeeze or market panic.
Some context:
As recently as 6 months ago, I was being paid more like 5% (so shorts were paying ~10%) to borrow TSLA. There was a glorious day or 2, I think back in August (maybe September), where I got paid 14% (short sellers paid ~25% that day I think). That's been my own, pretty recent and brief experience.
I'm far from an expert, but my understanding has evolved to this point of view.
1) Actual information relevant to short activity is intentionally delayed and kept opaque by the market. Thus we are left to pick through secondary measures to try and understand what is going on.
2) A close to real time (daily) view of demand is a composite view of:
- the shares available to borrow
- the interest rate paid to establish and maintain a short position
- the borrowing of shares brokerages in their Fully Paid Lending Program (brokerages make the least money on these shares, so they are the last shares lent to short sellers)
3) The best longer term view of demand is the actual number of shares short, reported 2x/month with a 2 week delay (hence my first comment about intentional obfuscation by the market).
4) I haven't seen anybody talk about this, but my own gut reaction and feel about the short market, is that it's awfully manual. I get the impression that Fidelity literally makes adjustments at the end of each day regarding the number of shares that are available, which shares to return to lenders, which shares to borrow from lenders, what rate to charge borrowers, etc.. The market adjustments are all just a bit clunky to be a fully automated market with bid/ask quotes and constant market changes.
SIDEBAR: In the bad old days, prior to about 3 months ago, Fidelity set the rate paid to borrow TSLA from me (and other FPLP participants) separately from the rate they charged shorts to borrow the shares from Fidelity. Today, Fidelity would pay me 60% of what they charge to lend out my shares, so that is one fewer seemingly daily adjustments they need to make.
The first bit of context, is that Tesla has a ridiculously large short position. Order of magnitude (I haven't looked up recent numbers) - something like 30M shares short out of 170M shares. So around 1/6th. Other companies are considered to have high short interest at 3 or 5% of shares outstanding.
(A second sidebar - even if I were somebody that sold shares short on occasion, the size of the outstanding short position would keep me out. The trade is crowded and in the event of a short squeeze ... well, let's just say that the theater is way too crowded to empty quickly when/if somebody yells fire. People are going to get hurt if that happens).
The interest rate paid to establish and maintain a short position tells us something about demand to borrow shares and establish (or maintain) short positions. At 1%, relative to Tesla's history, this is relatively low demand.
Meanwhile, whether brokerages are borrowing shares through their FPLP tells us something more about supply. The first thing to know is that very few companies are so heavily shorted that a brokerage will pay anything to borrow those shares. Of the dozen or so companies I own shares in, they are all eligible to be lent out via Fidelity's FPLP - only TSLA has actually been lent out (and TSLA was the reason I signed up in the first place).
Fidelity isn't currently borrowing my shares, so even if they are the last shares Fidelity wants to lend out, Fidelity also has no problem taking 2/5ths of 5% if shorts want to pay 5% to sell shares short. They probably prefer taking 2/5ths of 5%, because they're also getting all 5% on the rest of the shares they've lent out (they appreciate all you folks owning shares on margin!). This isn't currently happening, so while the short sale trade looks crowded to me, I also see lots of room for the market to accommodate more participants with little change in the cost to participate in the trade.
Thank you for the detailed response. I appreciate you taking the time to write all that out.
I generally agree with your post. I think the type of development I would like to see, as a long-term investor, is an orderly and convincing increase in SP as indicated by declining number of number of shares short and stable borrowing rate.
If stock jumps above $1,000 and the borrowing rate also jumps, I would interpret that as shorts are looking to get back in and the inexplicable volatility in TSLA will continue.
If Model 3 ramp up goes smoothly and Tesla Energy grows leaps and bounds as Elon predicted, then we may finally see a more stable stock that actually acts like a large-cap stock.
I guess the one thing I would slightly disagree with you is the size of the short vs. float. I recognize by traditional measures 31 million shares short out of 120 million float leads to a short ratio of ~26%. I believe, however, that this is misleading, because a large portion of the float is in the hands of very long-term investors that don't normally trade day to day, so their shares would not be available for shorts to use to cover in a potential short squeeze. I believe T.Rowe's, Fidelity's, Ballie Gifford's, now Tencent's (and my!) shares should be excluded from the float in this calculation, so I estimate that the real short to float ratio is around ~50%.
Having said this, if the stock zooms above $1,000 in the coming months, then sure, these shares would be in play as well. But given that these investors were adding millions of shares in 4Q16, they clearly believe $300-400 and maybe even $500 per share doesn't cut it.
Interesting times ahead...
