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.
