By now, everyone has heard of the battle going on between Gen Z and Millennials vs. Wall Steet. The Reddit message board @WallStreetBets has seen its population swell from 2.7 million to 8.8 million since the battle began.
At the heart of the riff is short selling, more specifically “abusive short selling.” What young traders have “discovered” is that more shares are short than exist in the public float and this exposes a market structure problem going back to the 1980s.
When the DTCC (Depository Trust & Clearing Corp.) began allowing journal entries to replace actual stock certificates, it opened a wormhole in the daily clearing operations for all U.S. stocks.
There are two types of short sales: exempt (market makers) and non-exempt (everyone else). Market makers are divisions of broker-dealers and are required to close out short positions at the end of each trading day in order to claim the market maker’s exemption.
This exemption allows them to short stock to a buyer without locating, borrowing, paying the rebate rate or the interest rate to borrow shares, as long as they cover before the end of the trading day. In 2005, the Securities and Exchange Commission passed Regulation SHO to address several loopholes in the previous rule requiring “affirmative determination.”
When that did not stop abusive short selling, an amendment was passed in 2008 called the Fair Market Making Requirement. While this reduced Fails to Deliver (under rule 204), it did not stop market makers from claiming the exemption and keeping short positions overnight.
Our firm has spent the last 16 years consolidating the tape of all U.S. stock exchanges and aggregating the sell short trade identifier for every stock in the U.S.
The data shows that short selling as a percentage of total trading volume exceeds what is considered a normal market with integrity.
Let’s use BlackBerry as an example. It acquired Irvine-based cybersecurity company Cylance for $1.4 billion in 2018. Chart 1 shows “Total Shares Shorted.” It displays all short sales in the aggregate (it does not account for covers as the SEC does not allow the purchase of buy-to-cover trade identifier data). Notice that an average of 36.19% of all trading is short selling. The volume weighted average price of all the short selling is $9.86 (as of Feb. 9). This means that as long as BlackBerry is above that level, shorts are losing money and a short squeeze is underway.
Chart 1 plots the “SqueezeTrigger Price” for BlackBerry and shows how on Jan. 14, 2021, the stock price exceeded the average price of all short sellers. When this happened, the stock exploded higher to nearly $29.00! Chart 2 is what a short squeeze looks like.
Why has it taken so long for retail investors to “discover” what so many Wall Street professionals have known for decades?
The answer is “crowd behavior.”
The WallSteetBets “Robinhood crowd” have access to free money, free money trades and free time.
This triangulation has created a new force to be reckoned with that has not been around since the dot-com boom of the late ’90s. Additionally, this group of 18 to 35-year-olds is fed up with the old guard and has mobilized in a way that creates “emergent behavior”, where 1+1 = 3. They did this via the purchase of short dated (2-4 weeks into the future) deep out-of-the-money call buying (very cheap naked call options), while simultaneously purchasing the underlying equity.
This technique allowed the group to lever up their bets by 30 to 100 times, effectively chasing the shorts out of BlackBerry in under two weeks. This is called a “Gamma Squeeze” and exposed an underlying vulnerability in institutional Wall Street. Leave it to a large group of “degenerates,” as they are referred to on Reddit, to outsmart the smartest people in the room. It seems you have to be the smartest people in the “chatroom” these days to compete against this 8.8-million-person strong army of young traders.
To sum it up, while Wall Street is referring to the recent short squeezes as a “side show,” it appears this group of tech savvy traders are making it the main show and calling it “Short Shorts.”
Beating short sellers is the main event for this group, and we applaud their ingenuity and David vs. Goliath mantra!
Editor’s Note: Corona del Mar-based Tom Ronk is co-founder and chief executive of BUYINS.NET, which alerts publicly traded companies to short campaigns against them. When Overstock.com founder Patrick Byrne was CEO, he used Ronk’s research to collect almost $35 million from Goldman Sachs and Bank of America’s Merrill Lynch for abusive short trading.
