The short selling storm
02 May 2018
With the ability to influence market volatility, short selling plays an important role in the finance industry, and while some areas are banning aspects of short selling, others are only just introducing it
Image: Shutterstock
Short selling has created a storm in the finance industry recently with much change and movement going on in this space. While some markets around the world are introducing short selling to boost activity, others are banning it. Short selling can be seen as a risk; it is the sale of a security that the seller has borrowed and if a security鈥檚 price declines then the short seller profits. Short sellers can affect volatility and liquidity.
Recently, the Canadian 网爆吃瓜 Administration (CSA) and Investment Industry Regulatory Organisation of Canada (IIROC) proposed a halt on cryptocurrency short selling, and the German financial regulator, the Federal Financial Supervisory Authority (BaFin), banned short selling on Wirecard, for a set period.
Argentina lifted its short-selling ban, and the Asia 网爆吃瓜 Industry and Financial Markets Association (ASIFMA) has proposed a workable securities lending regime in China. More recently, the Central Bank of Bahrain鈥檚 (CBB) issued new regulations in respect of short selling and giving securities on loan in an effort to develop the financial sector in the Kingdom of Bahrain.
This unbalance of opinion on short selling stems from the risk factors associated with it and institutions such as Nasdaq have called for more transparency in this area. Indeed, in early 2015, Nelson Griggs recommended tailored rules to prevent aggressive short selling and disclosure of short positions.
The vigour of volatility
Discussing the impact of short selling on market volatility, Sam Pierson, director of securities finance at IHS Markit, indicates that short selling can have a dampening effect on market volatility, for example in a market sell-off short sellers will often be buyers of stocks, seeking to lock in profits.
He comments: 鈥淭he lack of short positioning in developed markets in the latter half of 2018 may have contributed to the sell-off at year end, as there were fewer buyers to step in.鈥�
鈥淥n the other hand, short sellers actively increased positions throughout the Q1 2016 sell-off; the short covering came after the market had bottomed and if anything increased the volatility to the upside.鈥�
鈥淕enerally speaking, the presence of willing buyers at lower prices, and sellers at higher prices should function to provide liquidity where it is most needed and dampen volatility.鈥�
Ihor Dusaniwsky, managing director of predictive analytics, S3 Partners, argues that in an absolute sense, short selling adds to the overall liquidity in the market by providing both offsetting bids and offers to the general trend or momentum of buy-side order flow.
He cites: 鈥淭he short seller, who is often a contrarian, will sometimes be one of the few takers on the opposing, or 鈥榰npopular鈥� side of a trade. Stepping aside from traditional statistical analysis of market volatility and liquidity, short selling provides a counterpoint to the prevailing market voice which eventually spurs additional trading and analysis.鈥�
鈥淲hether it be the 鈥楾SLAQ鈥� versus the 鈥楥ult of Tesla鈥�, or shorting an Initial Public Offering (IPO) soon after its issuance, the short side of the market stirs the pot and energises both the long and short side into more dialogue, resulting in trading activity based on reinvigorated convictions.鈥�
Dusaniwsky also observes that long shareholders of heavily shorted stocks are always on the lookout for the next 鈥榮hort squeeze鈥�, which is an entry point to build their positions ahead of a rally. He added that short sellers, on the other hand, search out the overbought securities whose momentum is starting to peter out as the masses turn their buying attention to the next stock or sector that is beginning to outperform the market.
Meanwhile, Dusaniwsky also drew attention to the impact of social media and remarked that the conversation surrounding short selling at times has a greater effect on market volatility than the short interest data itself.
He outlines: 鈥淭he mere mention of a new Short Research Report (for example, Citron, Muddy Waters, etc.), a bearish call on CNBC by short selling legend Jim Chanos, or negative commentary made by famous activist investors like Carl Icahn or David Einhorn, can start a cacophony of internet clicks and send stock prices tumbling within just a few seconds.鈥�
鈥淲hile internet clicks and media chatter can affect the market temporarily, transparency into daily short selling activity reinforces the trends and validates additional trading activity.鈥�
Tesla trends
Not a stranger to the effects of social media, Tesla, the electric vehicle and renewable energy corporation, experienced extreme volatility last year. Tweets last year from Elon Musk on the privatisation of Tesla resulted in a lawsuit calling the firm鈥檚 operations into question. In the Tweet, Musk claimed that he would make Tesla private and that the funding for doing so had been 鈥渟ecured鈥�.
Shareholders responded by saying that this was an attempt to manipulate Tesla鈥檚 stock price and ruin plans for short-sellers
Currently, data suggests that there is a renewed interest in Tesla, Pierson outlined that for Tesla, IHS Markit currently estimates short interest at 31.4 million shares short, $8.5 billion, 23 percent of the free float.
He continues: 鈥淲e鈥檝e seen an additional 5.8 million shares borrowed since the end of February, suggesting a renewed interested in short exposure for the electric automaker. Short positioning peaked at just over $13 billion in June of 2018 and averaged $10.3 billion for the year, well above the current level.鈥�
鈥淕enerally speaking the short interest in share terms has moved inverse to price, so if the year-to-date (YTD) weakness in price persists we would expect to see the trend of increased short positioning remain in place. Tesla has been a good short in relative terms YTD, underperforming the Nasdaq by 30 percent in Q1.鈥�
Discussing the increase of shares shorted for Tesla this year, Dusaniwsky says: 鈥淲ith earnings coming out early next month; possible autopilot issues; car fabrication and delivery miscues; and a possible expansion of federal electric vehicle tax credits there will be enough volatility in the stock to move short selling in either direction.鈥�
BaFin鈥檚 ban
Elsewhere, BaFin recently banned short selling on Wirecard. BaFin notified the European 网爆吃瓜 and Markets Authority (ESMA) on 17 February 2019 of its intention to make use of its powers of intervention, introducing an emergency measure, which bans opening or increasing net short positions on shares issued by Wirecard鈥攅ither directly or through related instruments, for a duration of two months. According to BaFin, they stopped short selling on Wirecard because the falling share price caused uncertainty in the market.
Of this, Dusaniwsky suggests that this put Wirecard AG short sellers in a costly time-out. Dusaniwsky explained in his research that BaFin鈥檚 short sale prohibition turned the tables on short sellers, with no opportunity for them to continue beating down Wirecard鈥檚 stock price.
In February, at the time of the ban, Dusaniwsky cited: 鈥淏aFin might have stabilised the German market, and Wirecard in particular, over the short term, or they may have just closed the pressure valves and created the possibility of a flood of short selling in two months.鈥�
The ban also came under criticism from Fahmi Quadir, founder and CIO of Safkhet Capital Management LLC. In a letter addressed to Jean-Pierre Bussalb, head of short selling section, Quadir called the ban 鈥渂izarre鈥� and 鈥渂ackwards鈥�, and noted that as a trading strategy, short selling is widely acknowledged as beneficial and a necessary countervailing force to maintain market efficiency.
Quadir鈥檚 letter said: 鈥淥n 30 January [2019], Wirecard shares fell just 13 percent despite investor disappointment on weak fundamentals, emerging information related to potential fraud from internal Wirecard employees, and a dizzying near 300 percent share rally since 30 January, 2014.鈥�
Christian Schablitzki, managing principal at Capco, Germany, highlights that BaFin鈥檚 decision to ban short selling in Wirecard AG for two months through to 18 April to prevent potential negative impacts on the German financial system stemmed from the fear that any 鈥榚rratic losses鈥� in Wirecard stocks could have spill-over effects to other financial stocks, such as Deutsche Bank or Commerzbank, both of which were trading at relatively very low levels.
Schablitzki notes that the ban is more to do with maintaining overall financial stability than to Wirecard AG, which represents some 1.25 percent of the total value of the German DAX.
Andy Dyson, CEO of the International 网爆吃瓜 Lending Association, exclaims: 鈥淩eactions to the decision to suspend short selling in Wirecard were mixed. On the one hand, many felt this was a strong stance from the regulator, while others felt that all that short sellers had done was to focus attention on certain alleged accounting and financial fraud allegations within the company.鈥�
He continues: 鈥淲e should not forget here that all short sellers are doing at one level is to simply express the sentiment in a particular security. What is clear here is that the current short selling rules that apply across Europe that require any short positions to be against an identified borrow or locate, do appear to be working although the debate still continues about the role of the BaFin in this particular case.鈥�
Short selling shifts
In terms of trends, Pierson notes that it has been a challenging period for equity short sellers. He explained that the broad market rally in January saw the most expensive to borrow shorts significantly outperform, which reflects pain for short sellers.
Pierson continues: 鈥淓merging Markets were generally a fertile ground for shorts in 2018, however, Equity Multiplier (EM) broadly outperformed developed markets in January, which also caused reticence on the part of short sellers to start the year. US equities have regained their footing relative to broad EM, however, China-related equities have outperformed, further frustrating short sellers of Chinese firms listed in Hong Kong and US American depository receipts (ADRs).鈥�
鈥淐annabis is another popular sector for short sellers which has caused pain this year. The exchange-traded funds which track the Cannabis sector has significantly outperformed the broader market, however, the gap has narrowed in recent weeks.鈥�
Dusaniwsky predicts that two of the more lasting trends in 2019 are increased short selling in worldwide banking\finance sectors and increased short selling in the US\Canadian cannabis sector while a developing trend is unicorn IPO short selling.
Political factors can also be expected to impact short selling as Dusaniwsky affirms: 鈥淚ncreased short exposure in the Banking Sector has been fostered by Brexit fears in Europe; housing volatility in Australia and Canada; and interest rate uncertainty throughout the world. We鈥檝e seen total short interest in the banking sector (which includes banking, mortgage finance, asset management, custody banks, capital markets, investment banking, and brokerage) increase by 20 percent to $130 billion in short interest this year.鈥�
Reflecting on the effects of short selling, Dusaniwsky highlights that without daily transparency, short selling is invisible and sometimes barely affects price moves compared to long buying.
He concludes: 鈥淏ut in today鈥檚 new era of short sale transparency via public disclosures and continuous dissemination, this increases the relevance markedly in a historically opaque marketplace. Pandora鈥檚 box is open, short selling transparency will lead to more short selling as the practice becomes more recognised, understood and executed. Transparency will lead to larger short-side reading volumes as these speculators will also have the ability to be momentum movers, just like their buy-side brethren.鈥�
Recently, the Canadian 网爆吃瓜 Administration (CSA) and Investment Industry Regulatory Organisation of Canada (IIROC) proposed a halt on cryptocurrency short selling, and the German financial regulator, the Federal Financial Supervisory Authority (BaFin), banned short selling on Wirecard, for a set period.
Argentina lifted its short-selling ban, and the Asia 网爆吃瓜 Industry and Financial Markets Association (ASIFMA) has proposed a workable securities lending regime in China. More recently, the Central Bank of Bahrain鈥檚 (CBB) issued new regulations in respect of short selling and giving securities on loan in an effort to develop the financial sector in the Kingdom of Bahrain.
This unbalance of opinion on short selling stems from the risk factors associated with it and institutions such as Nasdaq have called for more transparency in this area. Indeed, in early 2015, Nelson Griggs recommended tailored rules to prevent aggressive short selling and disclosure of short positions.
The vigour of volatility
Discussing the impact of short selling on market volatility, Sam Pierson, director of securities finance at IHS Markit, indicates that short selling can have a dampening effect on market volatility, for example in a market sell-off short sellers will often be buyers of stocks, seeking to lock in profits.
He comments: 鈥淭he lack of short positioning in developed markets in the latter half of 2018 may have contributed to the sell-off at year end, as there were fewer buyers to step in.鈥�
鈥淥n the other hand, short sellers actively increased positions throughout the Q1 2016 sell-off; the short covering came after the market had bottomed and if anything increased the volatility to the upside.鈥�
鈥淕enerally speaking, the presence of willing buyers at lower prices, and sellers at higher prices should function to provide liquidity where it is most needed and dampen volatility.鈥�
Ihor Dusaniwsky, managing director of predictive analytics, S3 Partners, argues that in an absolute sense, short selling adds to the overall liquidity in the market by providing both offsetting bids and offers to the general trend or momentum of buy-side order flow.
He cites: 鈥淭he short seller, who is often a contrarian, will sometimes be one of the few takers on the opposing, or 鈥榰npopular鈥� side of a trade. Stepping aside from traditional statistical analysis of market volatility and liquidity, short selling provides a counterpoint to the prevailing market voice which eventually spurs additional trading and analysis.鈥�
鈥淲hether it be the 鈥楾SLAQ鈥� versus the 鈥楥ult of Tesla鈥�, or shorting an Initial Public Offering (IPO) soon after its issuance, the short side of the market stirs the pot and energises both the long and short side into more dialogue, resulting in trading activity based on reinvigorated convictions.鈥�
Dusaniwsky also observes that long shareholders of heavily shorted stocks are always on the lookout for the next 鈥榮hort squeeze鈥�, which is an entry point to build their positions ahead of a rally. He added that short sellers, on the other hand, search out the overbought securities whose momentum is starting to peter out as the masses turn their buying attention to the next stock or sector that is beginning to outperform the market.
Meanwhile, Dusaniwsky also drew attention to the impact of social media and remarked that the conversation surrounding short selling at times has a greater effect on market volatility than the short interest data itself.
He outlines: 鈥淭he mere mention of a new Short Research Report (for example, Citron, Muddy Waters, etc.), a bearish call on CNBC by short selling legend Jim Chanos, or negative commentary made by famous activist investors like Carl Icahn or David Einhorn, can start a cacophony of internet clicks and send stock prices tumbling within just a few seconds.鈥�
鈥淲hile internet clicks and media chatter can affect the market temporarily, transparency into daily short selling activity reinforces the trends and validates additional trading activity.鈥�
Tesla trends
Not a stranger to the effects of social media, Tesla, the electric vehicle and renewable energy corporation, experienced extreme volatility last year. Tweets last year from Elon Musk on the privatisation of Tesla resulted in a lawsuit calling the firm鈥檚 operations into question. In the Tweet, Musk claimed that he would make Tesla private and that the funding for doing so had been 鈥渟ecured鈥�.
Shareholders responded by saying that this was an attempt to manipulate Tesla鈥檚 stock price and ruin plans for short-sellers
Currently, data suggests that there is a renewed interest in Tesla, Pierson outlined that for Tesla, IHS Markit currently estimates short interest at 31.4 million shares short, $8.5 billion, 23 percent of the free float.
He continues: 鈥淲e鈥檝e seen an additional 5.8 million shares borrowed since the end of February, suggesting a renewed interested in short exposure for the electric automaker. Short positioning peaked at just over $13 billion in June of 2018 and averaged $10.3 billion for the year, well above the current level.鈥�
鈥淕enerally speaking the short interest in share terms has moved inverse to price, so if the year-to-date (YTD) weakness in price persists we would expect to see the trend of increased short positioning remain in place. Tesla has been a good short in relative terms YTD, underperforming the Nasdaq by 30 percent in Q1.鈥�
Discussing the increase of shares shorted for Tesla this year, Dusaniwsky says: 鈥淲ith earnings coming out early next month; possible autopilot issues; car fabrication and delivery miscues; and a possible expansion of federal electric vehicle tax credits there will be enough volatility in the stock to move short selling in either direction.鈥�
BaFin鈥檚 ban
Elsewhere, BaFin recently banned short selling on Wirecard. BaFin notified the European 网爆吃瓜 and Markets Authority (ESMA) on 17 February 2019 of its intention to make use of its powers of intervention, introducing an emergency measure, which bans opening or increasing net short positions on shares issued by Wirecard鈥攅ither directly or through related instruments, for a duration of two months. According to BaFin, they stopped short selling on Wirecard because the falling share price caused uncertainty in the market.
Of this, Dusaniwsky suggests that this put Wirecard AG short sellers in a costly time-out. Dusaniwsky explained in his research that BaFin鈥檚 short sale prohibition turned the tables on short sellers, with no opportunity for them to continue beating down Wirecard鈥檚 stock price.
In February, at the time of the ban, Dusaniwsky cited: 鈥淏aFin might have stabilised the German market, and Wirecard in particular, over the short term, or they may have just closed the pressure valves and created the possibility of a flood of short selling in two months.鈥�
The ban also came under criticism from Fahmi Quadir, founder and CIO of Safkhet Capital Management LLC. In a letter addressed to Jean-Pierre Bussalb, head of short selling section, Quadir called the ban 鈥渂izarre鈥� and 鈥渂ackwards鈥�, and noted that as a trading strategy, short selling is widely acknowledged as beneficial and a necessary countervailing force to maintain market efficiency.
Quadir鈥檚 letter said: 鈥淥n 30 January [2019], Wirecard shares fell just 13 percent despite investor disappointment on weak fundamentals, emerging information related to potential fraud from internal Wirecard employees, and a dizzying near 300 percent share rally since 30 January, 2014.鈥�
Christian Schablitzki, managing principal at Capco, Germany, highlights that BaFin鈥檚 decision to ban short selling in Wirecard AG for two months through to 18 April to prevent potential negative impacts on the German financial system stemmed from the fear that any 鈥榚rratic losses鈥� in Wirecard stocks could have spill-over effects to other financial stocks, such as Deutsche Bank or Commerzbank, both of which were trading at relatively very low levels.
Schablitzki notes that the ban is more to do with maintaining overall financial stability than to Wirecard AG, which represents some 1.25 percent of the total value of the German DAX.
Andy Dyson, CEO of the International 网爆吃瓜 Lending Association, exclaims: 鈥淩eactions to the decision to suspend short selling in Wirecard were mixed. On the one hand, many felt this was a strong stance from the regulator, while others felt that all that short sellers had done was to focus attention on certain alleged accounting and financial fraud allegations within the company.鈥�
He continues: 鈥淲e should not forget here that all short sellers are doing at one level is to simply express the sentiment in a particular security. What is clear here is that the current short selling rules that apply across Europe that require any short positions to be against an identified borrow or locate, do appear to be working although the debate still continues about the role of the BaFin in this particular case.鈥�
Short selling shifts
In terms of trends, Pierson notes that it has been a challenging period for equity short sellers. He explained that the broad market rally in January saw the most expensive to borrow shorts significantly outperform, which reflects pain for short sellers.
Pierson continues: 鈥淓merging Markets were generally a fertile ground for shorts in 2018, however, Equity Multiplier (EM) broadly outperformed developed markets in January, which also caused reticence on the part of short sellers to start the year. US equities have regained their footing relative to broad EM, however, China-related equities have outperformed, further frustrating short sellers of Chinese firms listed in Hong Kong and US American depository receipts (ADRs).鈥�
鈥淐annabis is another popular sector for short sellers which has caused pain this year. The exchange-traded funds which track the Cannabis sector has significantly outperformed the broader market, however, the gap has narrowed in recent weeks.鈥�
Dusaniwsky predicts that two of the more lasting trends in 2019 are increased short selling in worldwide banking\finance sectors and increased short selling in the US\Canadian cannabis sector while a developing trend is unicorn IPO short selling.
Political factors can also be expected to impact short selling as Dusaniwsky affirms: 鈥淚ncreased short exposure in the Banking Sector has been fostered by Brexit fears in Europe; housing volatility in Australia and Canada; and interest rate uncertainty throughout the world. We鈥檝e seen total short interest in the banking sector (which includes banking, mortgage finance, asset management, custody banks, capital markets, investment banking, and brokerage) increase by 20 percent to $130 billion in short interest this year.鈥�
Reflecting on the effects of short selling, Dusaniwsky highlights that without daily transparency, short selling is invisible and sometimes barely affects price moves compared to long buying.
He concludes: 鈥淏ut in today鈥檚 new era of short sale transparency via public disclosures and continuous dissemination, this increases the relevance markedly in a historically opaque marketplace. Pandora鈥檚 box is open, short selling transparency will lead to more short selling as the practice becomes more recognised, understood and executed. Transparency will lead to larger short-side reading volumes as these speculators will also have the ability to be momentum movers, just like their buy-side brethren.鈥�
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