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
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.
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.
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)
“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:
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%.
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 ([email protected])
To receive a FREE copy of our weekly newsletter, fill out the brief form on the top right side of our blog page: