Malt Liquidity 21
A short history of the "grudge" short squeeze
A Quick Vocab Lesson
short·selling: selling shares you do not own to get downside exposure to a stock. Generally used when you are too large of a trader to buy puts, want delta one exposure, or deem volatility too high on options and would rather just pay borrow cost.
short·squeeze: when rapid price movement upwards in a heavily shorted stock forces buying back of shares lest the float (read: supply of shares) runs out
In Which There Is No Protagonist
A short squeeze is not about company outperformance - while a heavily shorted company can unexpectedly do something positive, it is simply a catalyst, the same thing short-sellers (henceforth referred to as ‘shorts’) need in the first place for a stock to go down. Short squeezes are about demand manipulating the liquidity for the shares that the shorts have borrowed and sold to induce demand for the reduced supply of shares, “squeezing” the price higher.
Let's travel back a few years to see how this works - we begin with a bike ride.
…Ackman decided to join a group of a half-dozen dedicated cyclists, including Loeb, who take long bike rides together in the Hamptons… The two would cycle the 20 or so miles to Montauk, where they would meet up with the rest of the group and ride out the additional 6 miles to the lighthouse… As he and [fellow hedge fund manager Daniel] Loeb approached Montauk, Loeb texted his friends, who rode out to meet them from the opposite direction. The etiquette would have been for Ackman and Loeb to slow down and greet the other riders, but Ackman just blew by at top speed. The others fell in behind, at first struggling to keep up with the alpha leader. But soon enough Ackman faltered—at Mile 32, Ackman recalls—and fell way behind the others. He was clearly “bonking,” as they say in the cycling world, which is what happens when a rider is dehydrated and his energy stores are depleted…
As the other riders noted, it was really rather ridiculous for him to have gone out so fast, trying to lead the pack, considering his lack of training. Why not acknowledge your limits and set a pace you could maintain? As one rider notes, “I’ve never had an experience where someone has gone from being so aggressive on a bike to being so hopelessly unable to even turn the pedals…. His mind wrote a check that his body couldn’t cash.”
Nor was Ackman particularly gracious about the incident afterward, not bothering to answer e-mails of concern and support from others in the group until months later.
There are obviously other, more famous short trades, but the infamous saga of the Ackman Herbalife short is obviously the modern day hallmark of the “pure grudge” induced short squeeze. A key concept is that it is far easier to trade with the momentum, especially to the upside as markets are long-biased. As such, shorting requires a catalyst to profit - not only do you have to be right about the stock going down, you have to be right about the timing. As a result, modern day “activist” short sellers tend to hawk the fact that they’re short as much as possible - they need everyone to sell the stock with them, or else they lose borrow cost at best, and at worst, the price drifts up against them. This doesn’t bode well when you annoy every other person who has the size to place GDP-sized bets on stock, as seen in one of the funniest interviews CNBC has ever aired, where Ackman and Carl Icahn insulted one another on live television:
[Icahn] - "I wouldn't have an investment with Ackman if you paid me to do it; if Ackman paid me to do it .... As far as I'm concerned, the guy is a major loser. You know, Disraeli once said, Disraeli once said about somebody that spoke in the Parliament, a young guy that spoke in the Parliament, 'Young man, I'd be happy if I could be as sure about one thing in my life as you are sure of everything.'"
[Icahn] - "I never said that I want to be friends with you Bill. I wouldn't be friends with you. And you said to me, you'd like to be friends so we could invest together .... I wouldn't invest with you if you were the last man on earth."
Truly, high school never ends.
A decade of bad blood festering prior and the aforementioned argument on CNBC led to close attention being paid to Ackman’s HLF short: Ackman himself had shorted about 20% of the entire float. However, Icahn and Loeb both noticed that while the stock had dropped a lot on Ackman’s pontificating, he still had to cover his position at some point. So, naturally, they both bought significant stakes in the company - Icahn bought a fourth of the company, and other hedge funders piled in as well - and convinced the cash-rich company to do share buybacks, squeezing the stock and forcing Ackman to pay interest to maintain his short on top of having a position pushed so brutally against him. While there were many fundamental reasons the short wasn’t going to go to zero, even though Ackman was convinced otherwise, the pure market mechanics showed that size could prop up the price due to the low float with no other real catalyst to take the stock down. It’s simple supply and demand - when the supply gets squeezed, the equilibrium price moves up, and the shorts have to take a gamble on whether to close and bid up the stock and admit a loss as Ackman did half a decade later, let the position run against them further and risk further decrease of float, or get margin called, the embarrassing fate of having the broker throw in the towel for them.
Yesterday I wrote about GME, the only time where I saw a purported retail “grudge short squeeze” (with the added hilarity of WSJ interviewing a kid whose last name is call), or as Jim Cramer so delightfully put it, “they are plainly, openly plotting to blow up the shorts!” You can hear the giddiness in his voice, and I noticed the same reactions in myself and many seasoned traders and market watchers who saw a group of people inducing something that nobody ever really thought was possible for retail traders to do.
So how does it work in GME’s case? While the interest in the stock was driven up organically, through memes, there is a very valid point in that GME short interest was actually larger than the float (note that might not literally be the case, as these numbers are not totally updated in real time, and anything over 100% would require naked shorting - technically not allowed, but who really knows - but anything over ~40% short interest is an insanely crowded trade already). Theoretically, if the stock was bought up, all of these shorts would be put in full desperation mode, though the company is most likely destined for Chapter 11. Not only that, most retail traders are spread insensitive - they have no problem crossing spreads to get into an option position that they can post about or buying shares while crossing the spread, thus pushing the price up.
So we have three factors that make this a pretty risky short to hold, just from a microstructure standpoint: short interest as a large percentage of float, spread insensitive traders, and options-biased traders. Think about what happens when someone is filled on a call option - the market maker is now net short the call, and therefore short delta, so the market maker now buys some stock to delta hedge, reducing the supply further temporarily. Retail sees some sort of price movement relative to the purchases and starts bidding up and crossing over the spread on the shares, pushing the next price print to the ask. For each long trade, the price print effect cascades ticks higher and higher, and the float is slightly reduced. Let’s say one fund gets shaky hands, and closes out their position - the stock might not have dropped to zero, but they still get out with some profit. Even more buy pressure has been revealed, and all of a sudden, there is a mad dash to cover GME positions before retail makes it inevitable to be forced out of the position. Somehow, through coordinated memes and actually putting skin in the game behind them, these traders replicated organically what Icahn and Loeb did out of pure, shared spite with billions of dollars. I’ll dub this “greenroots” trading, as it’s a grassroots movement, but actually has money behind it.
You might have a couple questions, namely: how does this end? and why isn’t this done more often? Well, the squeeze is predicated on bid pushing the price up and sellers getting desperate and buying out the bidders, eventually bringing the stock back down to earth as volume dies down. Remember, Icahn had Loeb and a few other hedgies also buying a ridiculous amount with him. Without having a lot of buying pressure, it is impossible to buy up enough of the float to make shorts nervous, which is what makes this situation so miraculous - coordination is one thing, but actually having thousands of traders pull together the volume to pull it off is another thing entirely. Truly, this is a trade to be remembered.
On that note…