Short selling involves selling a stock you don't own in the hope of benefitting from a fall in the price. Here we look at the mechanics, and challenges of it, and list the lineup and recent changes of the most shorted stocks on the ASX. We also take a brief look at recent Director buying/selling as another potential source of market signals.
The process of short selling
The mechanics of the transaction require you to first find someone who is a long-term holder of the stock (a "stable borrow") who is willing to lend you their shares for an annualised fee prior to selling. The benefit to the owner is additional income from an existing investment they are already comfortable owning and have no near-term intention of selling. This is facilitated by stock loan desks at investment banks working in conjunction with custodians who have requested consent from the beneficial owners.
While the reason for the short sale is clear, the expression of that sale can take various forms. For example, any option or warrant sold may be hedged by an underlying short sale by the provider. A hedge fund trade may be a directional view or part of a pairs trade. Other longer-term structural short sales could involve hedging against convertible note holdings, for example.
The challenges of going short
Shorting is not cheap to do. It is more expensive to maintain, and also involves unlimited risks against limited gains, if it is an outright position. Some of the most explosive share price gains are associated with an exhaustion of short seller capital. For example, for one brief moment in 2008 Volkswagen was the world's biggest company by market value following a disclosure by Porsche of the full extent of its holdings in Volkswagen, which had been masked by OTC option contracts. It prompted speculation of a takeover attempt, causing Volkswagen's shares to rise rapidly. Big short positions in the stock were squeezed out, causing an even more violent rise in the share price.
CEOs and boards of companies targeted by short sellers are often very vocal opponents of the activity and will decry any slump in their share price as the action of foreign short sellers. Whilst it is a practice more common overseas than here, and is widely disliked, its presence is a sign of a market working efficiently.
A foreign short seller prominent in the Australian press recently puts it this way in his disclaimer: "We are investors. We are biased. So are other investors. So are the companies we discuss. So are the banks that raised the money for such companies. If you are invested (either long or short) in a company so are you. Just because we are biased does not mean that we are wrong."
The most shorted stocks on the market
The short sales information in the table below from UBS is gathered from data published by ASIC on a T+3 basis. (The ASX also lists significant short sales on a non-aggregated basis.) The table lists separately the main short positions for ASX 100 stocks and for smaller cap stocks.
The table shows the short positions as a percentage of float-adjusted shares outstanding. Domino's Pizza Enterprises (DMP), for example, has A$620M of stock sold short, equivalent to 22.4% of its float, making it the most shorted stock in the Australian market on that basis.
The table also calculates "Days-to-trade", the number of days trading (on average) needed to cover the short position. In DMP's case, it is 44 days of average trading. It is a shorthand way of looking at the potential market impact in the event of a "short squeeze" being triggered.
It is also worth looking at share trades made by company insiders. The table below, collated by Market Index, shows Director Transactions over the past week above a minimum value of A$20K.
The ASX requires company directors to disclose all such share transactions within 5 business days under 'Appendix 3Y - Change of Director's Interest Notice.'
Disclosure of director buying and selling can be a useful indicator of confidence in the company by well-informed insiders.
However, keep in mind that other motivations could possibly be involved, such as selling shares to fund a house purchase for instance.
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as a fundie, lending a stock out for a pairs trade or a protective hedge etc makes sense to me. but i have never really understood the logic for why you'd lend the stock to glaucus etc for example. Lending to a serious short seller implies that (i) you have a more insightful investment thesis than the shortseller and (ii) no negative newsflow is coming down the pipe, despite the presence of potentially vocal short seller. More importantly, by lending to the shortseller, you are actually enabling the scenario - which otherwise is not incentivised to occur - where the stock can rapidly and catastrophically go down. (Small Y from short fees << risk of massive capital loss). How does this ever make sense for a fundie? i would have thought that a serious approach by a major shortseller would be a trigger for potentially exiting a stock rather than lending it! I'd welcome some professional comments on this.
Short-selling is plain immoral and the various stock-markets should make it illegal. Symptomatic of greed ...the way Glaucus targeted BLA is a prime example, many mum and dad investors hurt by the big end of town yet again
For the benefit of context, worth noting that prior to recent stock purchases David Williams sold 5M shares @ $7.50 in March this year.. ahead of their weak May trading update.