Eat My Shorts
Short selling or “going short” is a term widely thrown around in finance by investors, fund managers and advisers. Although more complicated than your typical buy and hold strategy, a short enables an investor to profit off the decline of the price of a share or security. Simply, this works by the short seller borrowing shares from a lender then immediately selling them at what they believe is a high price. Then, when the investor is due to return the shares to the lender, they purchase them back, hopefully at a lower price, and keep the difference. In the past, these arrangements were complicated to set up but a rise in the popularity of derivatives such as Contract for Difference (CFDs) has made shorting increasingly accessible to everyday investors.
Like any investment strategy, short selling has its own set of pros and cons. Short selling allows you to make profits through leveraged investments that require little capital outlay. The strategy can also allow you to hedge a range of risks across your portfolio by adding positions that provide returns from downwards movements in markets, currencies and interest rates.
On the other hand, the strategy poses more risks than a traditional long investment. With a long position, your gains are unlimited whilst your losses are limited by the share price going zero. In a short position, the opposite occurs and your losses are theoretically unlimited. By going against the trend, Investors are also faced with non-traditional investment risks such as takeovers and short-squeezes which can impact a short position rapidly. You also must manage borrowing costs and margin accounts which further complicate the process.
In recent times, when it comes to shorting, the one company that continually has its name thrown around is Tesla. If you’re not familiar with the company, Tesla primarily specializes in the manufacturing of electric vehicles and the development of the technology associated with them. A few years ago, the price of the company’s shares was rallying strongly of the back of strong sales. However, a string of productions issues and legal ramifications following CEO Elon Musk’s infamous “420” & “short burn of the century” tweets have cast doubt over the future of the company.
Earlier this month and heading into the companies third-quarter earnings call, the Wall St analysts’ consensus earnings estimate was slated at -$0.15 per share with over 20% of the company’s stock being “held” in short positions. Telsa delivered a quarterly earnings call of $1.84 per share, significantly outperforming the consensus estimate by $2.01 or 1,340%. At the time of writing this piece, the company’s shares have soared over 30% to $328, hurting any short investors. With the stock around 15% off all-time highs, most short positions would likely be feeling the burn.
In this situation, it’s very likely the price of the shares have risen to a point where short-sellers would begin to receive margin calls from their lenders. Investors are faced with two options, they can either top up their account with more cash allowing them to continue to hold their short position or, buy the shares back on market to close out their position in a phenomenon known as a short-squeeze.
A short squeeze results in increased buying volume that ultimately drives up the stock further than it theoretically would have if investors weren’t forced into buying.
Currently, it seems Elon has come good on his promise for the “short burn of the century”. The large discrepancy in consensus and delivered results highlights how analysts continue to have difficulty forecasting the company’s cash flows. The longer-term outlook for the stock remains hazy but if the company continues to exceed expectation it won’t be long until they’re back in the good books.