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Short Interest Explained

Covered call writers and put-sellers are always looking for metrics to improve trading results. Recently, we have had several inquiries about adding short-interest to the screening process. Over the years we have enhanced our Premium Member Stock and ETF Reports based on feedback we have received from you, our members. For example, we added ex-dividend date information to our stock reports and implied volatility stats to our ETF reports. Obviously, we must limit the information provided such that the reports are user-friendly and of the highest quality. That is what we strive for. Although short interest is not one of our BCI screens, some of our members have added this as an additional screen and I thought we might address it with you in a blog article.

DEFINITION of Short Interest

The quantity of stock shares that investors have sold short (borrowed from the broker and then sold) but not yet covered or closed out. Short interest is a market-sentiment indicator that tells whether investors think a stock’s price is likely to fall. Short interest can also be compared over time to examine changes in investor sentiment. Investors use short interest to make predictions about the direction a particular stock is headed, and to measure the bullishness or bearishness of investors’ sentiment towards the market as a whole.

Short interest can be calculated as a percentage by dividing the number of shares sold short by the total number of outstanding shares. For example, 5% short interest means that 5% of the outstanding shares are held short. Short interest can also simply be expressed as the number of shares sold short but not yet covered or closed out. Firms are required to report their short positions as of settlement on the 15th of each month. A list is published eight business days later.

Short interest data as published in the Wall Street Journal

 

short interest and covered call writing

Short interest stats as seen in the Wall Street Journal

 

Related definitions

Settlement Date:  The date specified for delivery of securities between securities firms. This date marks the official date for change of ownership and is used for accounting for long or short positions.

Short Interest:  The total number of shares of a security that have been sold short by customers and securities firms that have not been repurchased to settle outstanding short positions in the market.

Average Daily Share Volume:  The number of shares of stock traded each day, averaged over a one-year period.

Short-Interest Ratio: The number of shares sold short (short interest) divided by average daily volume. This is often called the “days-to-cover ratio” because it determines, based on the stock’s average trading volume, how many days it will take short sellers to cover their positions if positive news about the company lifts the price.

Days to Cover:  Calculated as the aggregate short interest for the month divided by the average daily share volume traded between short interest settlement dates. If days to cover is between 0 and 1, it is rounded up to 1 on Nasdaq.com.


A review of short selling

Short selling is the opposite of buying stocks – it’s the selling of a security that the seller does not own, with the expectation that the price will fall. If, after a period of time, the stock price declines, you can “close out” the position by buying the stock on the open market at the lower price, return the stock to your dealer-broker and realize a gain. However, if the stock price rises, you lose money because you have to buy the stock back at a higher price. In addition, your broker-dealer can demand that the position be closed out at any time, regardless of the stock price. This demand typically occurs only if the dealer-broker feels that the creditworthiness of the borrower is too risky for the firm.

 

Short interest expressed as a percentage example

A stock with 1.5 million shares sold short and 10 million shares outstanding has a short interest of 15% (1.5 million/10 million = 15%).

Most stock exchanges track the short interest in each stock and issue reports at month’s end. These reports are great for traders because by showing what short sellers are doing, they allow investors to gauge overall market sentiment surrounding a particular stock.

 

Interpreting Short Interest

A large increase or decrease in a stock’s short interest from the previous month can be a significant indicator of investor sentiment If BCI’s short interest increased by 10% in one month this means that there was a 10% increase in the number of people who believe the stock price will decrease. Such a significant shift provides good reason for investors to research this matter in more detail. A great site for this is: www.finviz.com.

A high short-interest stock should be approached with an open mind. Short sellers have been known to be wrong from time to time. In fact, many contrarian investors use short interest as a tool to determine the direction of the market. The rationale is that if everyone is selling, then the stock is already at its low and can only move up. These investors interpret a high short-interest ratio as a bullish signal because eventually there will be significant upward pressure on the stock’s price as short sellers cover their short positions (i.e. buy back the stocks they borrowed to return to the lender).

If BCI has a short interest of 150million shares, while the average daily volume of shares traded is 140 million. The calculation (150,000,000/140,000,000), determines that it would take 1.07 days for all of the short sellers to cover their positions. The higher the ratio, the longer it will take to buy back the borrowed shares – an important factor upon which traders or investors decide whether to take a short position. Typically, if the days to cover stretch past eight or more days, covering a short position could prove difficult.

 

The NYSE Short Interest Ratio
The New York Stock Exchange short-interest ratio is another metric that can be used to determine the sentiment of the overall market. The NYSE short-interest ratio is the same as short interest except it is calculated as monthly short interest on the entire exchange divided by the average daily volume of the NYSE for the last month. For example, suppose there are five billion shares sold short in May and the average daily volume on the NYSE for the same period is one billion shares per day. This gives us a NYSE short-interest ratio of five (five billion /one billion). This means that, on average, it will take five days to cover the entire short position on the NYSE. In theory a higher NYSE short interest ratio indicates a more bearish sentiment towards the exchange.

 

Short Squeeze 

Some bullish investors see high short interest as an opportunity. This outlook is based on the short-interest theory. The rationale is, if you are short selling a stock and the stock keeps rising rather than falling, you’ll most likely want to get out before you lose a significant amount. A short squeeze occurs when short sellers are scrambling to replace their borrowed stock, thereby increasing demand and decreasing supply, forcing prices up. Short squeezes tend to occur more often in smaller cap stocks, which have a very small float (supply), but large caps are not immune to this situation.

 

Discussion


Although it can be a telling indicator, an investment decision should not be based entirely on a stock’s short interest. Unlike the fundamentals of a company, the short interest requires little or no calculations. Half a minute of time to look up short interest can help provide insight into what sentiment investors have toward a particular company or exchange. The BCI methodology does not incorporate this metric in its 1-month option-selling strategies but encourage those who value this metric to include it into the decision-making process.

 

Upcoming webinars (I am an invited presenter/ hosted by other venues)

9/2/2015: www.winvesting.com

“The Basics of Covered Call Writing plus a Real-Life Trade”

9/9/2015: “All Stars of Option Trading” pre-event webinar

A 20-minute overview of some of the topics I expect to cover at the New York Stock Exchange discussion panel the following week.

Links to both events will be shared on this site once the host companies send them to me.

 

Progress on the Complete Encyclopedia…Volume 2:

I am reviewing the proof and once I approve it, printing will begin. I will make this book available to our members on this site first and shortly thereafter place on Amazon.com. Look for promo codes for early-order discounts:

 

covered call writing book

Encyclopedia for Covered call Writing Volume 2

 

Market tone

Global stocks suffered a rough week, with European stocks suffering the most, due to China’s surprise currency devaluation and the eurozone’s disappointing economic growth. US reports were mostly positive, as has been the case for quite some time. This week’s economic reports:

  • US retail sales turned around in July, increasing by 0.6%, and June’s retail sales were revised up to flat from the previously reported 0.3% decrease
  • US industrial output increased 0.6% in July, the fastest pace in eight months
  • Factory production rose by0.8%, mainly due to a 10.6% jump in motor vehicle output
  • US small businesses were more confident in July than in June, which had marked a 15-month low in the National Federation of Independent Business’s Small Business Optimism Index. With 7 of 10 index components rising in July, business owners expect strong sales and inventory growth over the next six months
  • The University of Michigan consumer sentiment index fell from a final July reading of 93.1 to a preliminary August score of 92.9
  • Prices for imported goods fell 0.9% from June to July as oil prices declined and a strong US dollar exerted downward pressure
  • US non-farm productivity increased at a 1.3% seasonally adjusted annual pace in the second quarter and was 0.3% higher than a year earlier
  • Initial jobless claims increased 5,000 to 274,000 for the week ended 8 August
  • Continuing claims rose 15,000 to 2.27 million for the week ending August 1st

For the week, the S&P 500 rose by 0.67% for a year-to-date return of 1.59%.

Summary

IBD: Uptrend under pressure

GMI: 3/6- Buy signal since July 30, 2015

BCI: This site remains bullish on the US economy but is also concerned about the market’s analysis of and reaction to the devaluation of the Chinese currency and the imminent rise in short-term interest rates by the Fed next month or in December. Barring other issues, the market should then re-focus back on corporate earnings, I believe a positive for the market. At this time, I am using only in-the-money call strikes. This is also a perfect environment for put-sellers to sell out-of-the-money puts before entering covered call trades.

Wishing you the best in investing,

Alan (alan@thebluecollarinvestor.com)

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About Alan Ellman

Alan Ellman loves options trading so much he has written four top selling books on the topic of selling covered calls, one about put-selling and a sixth book about long-term investing. Alan is a national speaker for The Money Show, The Stock Traders Expo and the American Association of Individual Investors. He also writes financial columns for both US and International publications along with his own award-winning blog.. He is a retired dentist, a personal fitness trainer, successful real estate investor, but he is known mostly for his practical and successful stock option strategies.

26 Responses to “Short Interest Explained”

  1. Raymond August 15, 2015 11:06 am #

    Alan,

    Since you are considering only in the money options, how do you decide which ones to use?

    Thank you.

    Raymond

    • Alan Ellman August 15, 2015 12:48 pm #

      Raymond,

      I first set my monthly goal for initial returns (2-4%/month). Then I will look for the strike that generates the greatest downside protection. In a bear market environment, this means that my initial time value returns will be closer to the 2% than the 4% in exchange for greater downside protection of that profit. The multiple tab of the Ellman Calculator will do the math for us.

      Alan

  2. Jay August 15, 2015 12:10 pm #

    Alan,

    For fun and the sake of discussion let’s kick the ‘ol football around on your suggestion above this might be a perfect environment to sell cash secured puts.

    I agree this is a great time to cover stocks with calls near or even in the money as that is a bearish strategy at a likely bearish time.

    But selling cash secured puts, a bullish strategy, at a bearish time seems like asking for trouble. The degree OTM can mitigate but if one is bearish why accept the risk of an above market stock purchase or expensive exit strategy?

    Thanks, hope your Giants are looking good for this season! – Jay

    • Roni August 16, 2015 12:06 pm #

      Great point Jay,
      this question has always bothered me about the cash secured put selling idea.
      Roni

    • Steve Zoller August 16, 2015 12:39 pm #

      Jay, I have three thoughts.

      1) Whether you’re bullish or bearish, never sell a put at a strike price that you’re not willing to buy the stock for.

      2) Selling a put is no more bullish than buying a stock and selling a call. If you’re willing to do one, you should be willing to do the other.

      3) If you’re confidently bearish, then you probably shouldn’t be doing either strategy at the moment.

      • Jay August 16, 2015 1:55 pm #

        Steve and Roni,

        Thank you for your thoughtful kind replies.

        Roni, a build on your thought is I have found it a question of market conviction: if I am neutral or bullish I love selling puts and put vertical spreads below the indexes or a given stock. The reverse when bearish.

        Now if I could only get it right :)!

        Steve, thanks for your 3 excellent points. I agree with 1, well stated. It is worthy of the definitive term “never”!

        I agree on 2. Though if you are very bullish on a stock, particularly a growth stock in a “sexy” sector like internet, biotech, cyber security, robotics or semi conductors you are better off not writing calls. Just hold if you own it and sell the puts if you do not. When in favor those stocks go up more in a week or even a day than you will get writing calls for a month!

        I will engage friendly debate with you on thought 3: if confidently bearish – as I am so I will stick my neck out for September expiry – I write ATM or ITM calls on the stocks I plan to hold. If I get an up side surprise, get called or have to spend a few bucks on exit strategies so be it. If not I earned rent on property I intended to keep regardless. I write lots of calls when I am bearish!

        Wishing you both a successful new week ahead… – Jay

        • Roni August 16, 2015 3:51 pm #

          Hi Jay, hi Steve,
          it’s pleasant to exchange ideas with you.
          In my opinion, both of you are correct.

          My problem is that I’m chicken.
          Therefore, I cannot sleep when I have an unprotected position.
          So, I follow Alan´s method by the rules:
          Sell covered calls, ATM most of the time. OTM when (he is) bullish, and ITM when (he is) bearish.

          Bearish or bullish, I only buy stocks that are green on the latest BCI Weekly Stock Screen.
          They are validated by IBD for fundamentals, and verified by Alan and his team for technicals.
          It is impossible for me to do better.

          My calls are always 4 weeks or less from expiry Friday, and it seems to be a very long time.

          Good luck to you too next week – Roni

          • Jay August 16, 2015 4:16 pm
            #

            Roni,

            A long time ago I was a pilot in our military. We had a saying: “There are old pilots and there are bold pilots. But there are no old bold pilots”.

            Being a chicken is often a good thing :). And sleep at night is priceless…..

            It is indeed a pleasure to exchange ideas here on Alan’s comment board. – Jay

          • Roni August 18, 2015 3:24 pm
            #

            Lol Jay,
            thats really a very good saying. Thank you so much.
            See you – Roni

  3. Barry B August 15, 2015 5:31 pm #

    Premium Members:

    This week’s Weekly Stock Screen And Watch List has been uploaded to The Blue Collar Investor premium member site and is available for download in the “Reports” section. Look for the report dated 08/14/15.

    Also, be sure to check out the latest BCI Training Videos and “Ask Alan” segments. You can view them at The Blue Collar YouTube Channel. For your convenience, the link to the BCI
    YouTube Channel is:

    http://www.youtube.com/user/BlueCollarInvestor

    Best,
    Barry and the BCI Team

  4. Ron August 16, 2015 5:16 pm #

    Hello Alan, I hope all is well with you and the BCI team.

    Great explanation of short interest. I understand it a bit better now.

    Regards,

    Ron

  5. Alan Ellman August 17, 2015 7:47 am #

    Selling puts in a bear market environment:

    To continue this on and off-line discussion:

    When there is overall market concern we look to selling in-the-money calls and out-of-the-money puts. The deeper ITM and OTM we go, the more protection we have from price decline but the lower the option returns. It’s a trade-off. Both strategies can be tailored to overall market assessment, both bullish and bearish as long as personal risk-tolerance permits.

    Let’s have a look at CELG and assume we want more protection at the expense of lower returns. Here are the stats before market opens on 8/17/2015 with CELG trading at $129.24:

    The 9/18/2015 $120.00 deep ITM call generates a 1-month return of 0.5% ((6% annualized) with 7.1% protection of that profit. The screenshot below (middle column) shows the calculations for the $120.00 deep OTM cash-secured put. It shows an annualized return of 12.20% and, if exercised, a purchase price 8.13% below current market value. This is equivalent to the downside protection of the $120.00 call. Furthermore, if we sold the put and it was exercised, we could then write a deep ITM call and continue to generate income with significant downside protection.

    There are many ways to make money in the market as well as different approaches to protecting our capital. As educated investors, we must each decide which approach is best for our particular trading style.

    Thanks to our members for your valuable feedback. This is how we learn from each other.

    CLICK ON IMAGE TO ENLARGE & USE THE BACK ARROW TO RETURN TO BLOG.

    Alan

  6. Nate August 18, 2015 2:02 am #

    To expand on Jay’s strategy of selling ATM or ITM calls on long term holdings in a bear market environment. Say you may not care about generating a profit this month on your long-term holdings but rather prefer to keep the gains you have had during a run. You expect the market to be lower for the next month but your not sure if it will be a big drop or not. You could sell a higher strike and get a bit more premium but you don’t want to risk it falling below the strike price. Let me know if you see a flaw in this thinking.

    Say you have AAPL bought at $95 and its at $117 you think it is going down over the next month and you just want to protect the profit you made until market improves. So you sell a deep ITM call at $100 for $17.40. This protects you all the way down to 99.60 without a loss (from current price). No gain for the month just enough to cover commissions. At the end of the month AAPL is at $108. On expiration Friday the option is trading near parity. So you pay $8.20 BTC. You lost $9 in the stock but essentially picked up the $9 in the option sale. Break even for the month. And slept better at night. The next month looks a bit more bullish so you just let AAPL run freely.

    Does that seem like a rational strategy for someone just trying to preserve capital for the month with a huge downside protection?

    Also say the next month it happens to get back to $117 then that’s where you see extra profit because without the CC you would have lost $9 and then got $9 back (even for both months). With the CC you broke even the first month then got $9 the next month. Putting you $9 ahead from not selling the CC.

    • Jay August 19, 2015 6:07 pm #

      Nate, that sounds like great defense, good math and rational to me! I certainly invite others to chime in….

      Another nuance to consider: is the $95 AAPL cost basis you are defending indeed your true one? Meaning, does it include reductions for past dividends and cc’s where you kept the shares, got paid and kept the premium? You may have more wiggle room for a pullback than you think!

      Since I mentioned I use those strategies on stocks I want to keep I tend to not write deep enough to protect a cost basis only deep enough to protect reasonable price proximity for a month considering the beta of the stock, any media sentiment about it or a next support level that could fail.

      But I follow your excellent example and can see why you would do as outlined. Thanks for the idea! – Jay

      • Nate August 21, 2015 1:21 am #

        Jay, I have not considered the addition of dividends and other CCs that reduce the cost basis. So many of my long term holdings are lower based on those additions. I usually just count those as a bonus. :). I would have more wiggle room from a loss but gains would be diminished at least in the the short term without a covered call at some level.

        Of course if my market assessment is wrong and the position is higher I miss out on any new price gains. So as with any other CC there is a trade off between protection, extra premium and capped growth potential.

  7. Richard August 19, 2015 1:07 am #

    Alan,

    I have been using the OTC VTS web site to do some virtual trading of covered calls. I notice that on some stocks, there are several expiration dates during the month. Is this the case for the “real life” option trading? Why do some have multiple expiration dates and some do not?

    Thanks,

    Richard

  8. Adrian August 19, 2015 5:05 am #

    Alan, I am still a bit unsure if I am picking the right stocks to use for my trades which are still paper ones. I am wondering if I need to make more effort to find only the ones that are uptrending instead of having some that are channelling s/ways, so of my questions the first two will explain what I mean;-
    1. When buying a stock you have said that we should buy one where all chart technicals look positive,- as shown on P.75 of encyclopaedia.
    I do agree too, but I am not sure if I should be systematically searching through the entire lists of stocks on Premium report, until we have found a few resembling these positive charts. Because like I had said once before, I would have to first only look at the cheaper stocks in my price range up to $50, of a 5 stock portfolio.
    And it just seems to be quite rare(at least at the moment) to find some suitable and good liquidity/returns too for these above requirements.
    So what I am asking here is should I be alright just going with any that maybe are instead channelling s/ways with mixed technicals, – or should I first try raise my price limit from $50/stock up and up until I find 5 stocks/ETF’s with the very positive charts that you have always depicted for us to favour?(if there aren’t already enough under $50 for me?)

    2. Is it a good idea for me to keep a seperate list of stocks that are from the ‘failed one or more screens’ list of the premium report, but only for those small amount of stocks there that have passed everything but the technicals(MACD/slow stochastics)having a ‘N’?
    I was thinking if I was ever short of a new stock to use, then without having to go to an ETF report, if the chart/technicals were positive at this time maybe I could use one of them? (and creating a new screen of stocks after each premium report is out?)

    3. Also in regards to the chart when there is a divergence on an indicator, then are you always viewing these on the price closes or on the bar/candle wicks?(I usually change to “price closes” as this is what I had read is more reliable- would you agree too?)

    I look forward to know what you think on this, and then I will get a clearer direction on things and if I need to give more time in to the stock choices or not. Thanks for your help

    • Alan Ellman August 21, 2015 11:10 am #

      Adrian,

      1- No need to go through the charts regarding technicals. All stocks with completely bullish chart patterns are highlighted in bold in our Premium Reports.

      2- No need to keep a separate list of stocks that failed the current week but were previously on our “Running List” We keep that list for you in the shaded areas of the report and these stocks will not be eliminated entirely from our reports unless they have failed 3 weeks in a row. ALL STOCKS LOCATED IN THE WHITE CELLS (BOLD OR NOT) ARE ELIGIBLE.

      3- We base our technical assessment on market close as of 4 PM ET on the Friday prior to the report. I would agree that this is more reliable than daily highs and lows.

      Alan

  9. Alan Ellman August 19, 2015 5:24 pm #

    Premium members:

    This week’s 6-page report of top-performing ETFs and analysis of ALL Select Sector Components has been uploaded to your premium site. The report also lists Top-performing ETFs with Weekly options.

    It is interesting to note that all 4 of the Inverse ETFs that we follow are now out-performing S&P 500 over the past 3 months. This is extremely rare and a reflection of the difficult market we are experiencing. Selling options is also a hedge against short-term bear and neutral markets like we have now. As I have stated the past few weeks, I am using only in-the-money strikes until the market turns around.

    For your convenience, here is the link to login to the premium site:

    http://www.thebluecollarinvestor.com/member/login.php

    NOT A PREMIUM MEMBER? Check out this link:

    http://www.thebluecollarinvestor.com/membership.shtml

    Alan and the BCI team

  10. Richard August 20, 2015 4:18 am #

    Just did a trade yesterday I normally would not do, buy to open GOOGL 680 C exp 9/4/15
    Sold to close less than 24 hrs later and the profit on 1 contract was $’620.

    • Jay August 20, 2015 5:26 pm #

      Richard, great trade!

      Please remember the tale of the Siren’s from your reading of Homer as a youth: they want to draw you onto the rocks.

      Options buying speculation can be a Siren’s call. Stay away from the rocks :).- Jay

  11. Nate August 21, 2015 10:52 am #

    Looks like the market couldn’t hold just a few more days to let my options expire in the money. In September I will be purely paper trading. These rough markets will help me build my skills but not at the risk of real money. :)

    • Alan Ellman August 21, 2015 11:12 am #

      An astute point by Nate. If we can negotiate the current market, we can negotiate all markets.

      Alan

  12. Keith August 21, 2015 10:59 am #

    Alan,

    What do you think about current market? What is the strategy to use?

    Keith

    • Alan Ellman August 21, 2015 11:16 am #

      Keith,

      Check out the “Emergency Management Report” in the “resources/downloads” section of the Premium site. It will detail:

      1- ***Selling ITM call strikes
      2- Using low-beta stocks
      3- Using OTM put strikes to enter a covered call trade
      4- Lowering initial monthly goals to 1-3%
      5- Using low volatility ETFs
      6- Using inverse ETFs (extreme situations-we’re not there yet in my view)

      Details with examples are in the report.

      Alan

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