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The whole Gamestop debacle has proved how profitable short squeezes can be. It essentially allows you to pressure large hedge funds who shorted too hard. So I was wondering, why aren't there already automated systems in place by other funds that monitor the short interest of different stocks and look for opportunities to capitalise on it. Here's how I imagine it:

  • Look for stocks that have a short interest higher than 50%
  • automatically buy at least 50% of the float that stock
  • refuse to sell under any circumstances and just wait for the price to rise

Is there a reason this wouldn't work?

smci
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user2741831
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4 Answers4

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I think this question makes false assumptions that are prevalent at the moment in the WSB rhetoric and echoed in the media. The claim that short squeeze "allows you to blackmail large hedge funds who shorted too hard", is not only sloppy/inaccurate (it can help you win a trade, not "blackmail" anyone?), but the over-the-top valence of the phrasing is indicative of making too much out of what happened. Newbie traders who just "discovered" what a short squeeze is a week ago, are explaining it like it's some genius hack they invented. On the contrary it's a well known, common thing.

Hedge funds are playing football against each other all the time, that's what they are all about. When X finds an angle, like Y and Z are over leveraged in shorts (as one example), X would try this same move on them, and then they'd play chicken on who can move the market. This is business as usual.

Every hedge fund (and individual trader) has different (proprietary) strategies for looking for different kinds of opportunities in the market. A short squeeze is one of many, and certainly there are already many firms that incorporate it into their filters and likely many of them have automated systems to look for those opportunities. So the premise of the question is wrong, there are people looking for this. That's not to say finding someone with a lot of shorts is an automatic good opportunity, further analysis is required (see other answers).

So there is nothing new or unique about this, despite how cool WSB people feel for participating in it. The only difference here is the "new hedgefund" WSB is chaotic neutral, and the rules of engagement (of stock chicken) are thrown out of wack. For example normally players in an instrument know who is interested in that instrument and how deep their pockets are, who they are playing against. They are not expecting a herd of retailers willing to endlessly buy something with no exit strategy. There is always irrational money but usually it is not coordinated and lost in signal/noise. They are expecting to play against rational agents who have an interest in protecting their capital and thus expect their opponents to play in predictable ways that allow for situational analysis. But the people buying this are (excuse the analogy) basically financial suicide bombers, most of them will lose what they put in buying higher and higher at prices that are over inflated (because they themselves are deliberately over inflating it). While a handful who bought in early and take profit early will make a killing, the rest will lose what they put in. And at least on the surface of their rhetoric, they are fine with losing their money (to early WSB people and hedgefunds B-Z) if it means hurting hedgefund A. Even still, as odd of a situation as that is, there's an adage for it: "the market can remain irrational longer than you can stay solvent". This was hedgefund A's mistake, believing that they could handle what they assumed would be a small amount of irrational money, and underestimating how much capital would come from viral memes on reddit, they doubled down, and lost.

user1169420
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    I too think this is a good high-level summary but I think it would be helpful to elaborate on what exactly made it work in this situation. In other words, what is missing from the OP's scheme? I don't see this in other answers, just hand-waving "it's not that simple" kinds of answers. One relevant factor seems to be the combination of a short-squeeze and a gamma-squeeze. The other thing I'm puzzled about here is why didn't any hedge funds execute a similar move. Blackrock hold/held 13% of GME, for example. – JimmyJames Feb 01 '21 at 22:19
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    OP is asking "why don't people/funds apply this strategy in every scenario", the only possible answer for that is "it's complicated, it depends on each scenario". As for why no one did it earlier in this scenario, I can only speculate the amount of capital needed, and the length of time they might have had to tie it up, didn't look great in a risk analysis. "Refuse to sell under any circumstance and wait for price to rise" is not sane professional risk management. You can say this to chaotic neutral redditors throwing money at lols, but not investors in your fund. I'm just guessing though. – user1169420 Feb 01 '21 at 22:54
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    And lost? Did I miss something? Did they go bankrupt already? – user253751 Feb 02 '21 at 09:45
  • Great answer through and through, really covers well both the actual value play going on, as well as the irrational aspect that does not really capitalize on that value. – Grade 'Eh' Bacon Feb 02 '21 at 14:05
  • "As for why no one did it earlier in this scenario, I can only speculate the amount of capital needed, and the length of time they might have had to tie it up, didn't look great in a risk analysis.", at $20 the market cap was less than 1.5 billion. Only a fraction of that was needed to cause this upward spiral which was quite rapid. Do you really think that hedge funds don't have access to more capital than a bunch of average Joes betting their savings? Blackrock (which already owned 13% of the stock at the end of the year) manages more than $8 trillion in assets. – JimmyJames Feb 02 '21 at 14:55
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    No need to excuse the WSB == financial suicide bombers analogy, it's perfect. I'd upvote for that alone. – jamesqf Feb 02 '21 at 16:54
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The reason this doesn't work is because of the real world: a failing company can declare bankruptcy, which they would declare to protect themselves from creditors, the creditors would be bondholders who have a contractual claim to money from revenue and assets, and the bankruptcy overrides the contract and lets a judge re-sort the claims.

Shareholders are behind bondholders, and usually get nothing, so the shares would be worth $0.00000 so it is completely rational to short a failing company that has no source of revenue or capital, because you deliver the shares back to their original owner at $0.00000 in the future, and you keep the difference from the price you borrowed and sold them at, and $0.00000 which is always a 100% delta, and if you yourself are leveraged then it is a 100% delta * leverage.

This works most of the time. The death spiral is real. Such automated systems exist but the same people running them also don't want to be stuck with illiquid shares.

JimmyJames
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CQM
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    So a proper short squeeze only works when the company behind the stocks isn't actually failing? Seams like all you need is to figure that out on a case by case basis and the system could work – user2741831 Feb 01 '21 at 09:08
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    @user2741831 there are fundamental investors and activist investors that have this as their entire market strategy, but yes, the opposite of automated. Many short sellers can easily hedge their bets to the upside, making a squeeze unlikely just because the price moved against the short bet. The primary way to squeeze the shorts is to coordinate that every shareholder requests their shares back, aka turning off the borrow. This level of coordinated market action is legal. – CQM Feb 01 '21 at 14:42
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    But it seems to me that the response to over-shorting GameStop (and perhaps other companies) is entirely unrelated to the inherent value of the company. Sure, management & board members who held blocks of stock acquired at the older, realistic valuation are now quite wealthy (assuming they sold near the high), but when the frenzy's over, GameStop will go back to being a gradually failing business. – jamesqf Feb 01 '21 at 17:56
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    Hypothetically, what if Gamestop declared bankruptcy during the short squeeze? Could the longs not continue to buy/hold and would the shorts still need to cover? The actual value of the company is totally irrelevant to what's happening with the current stock price of this company. – JimmyJames Feb 01 '21 at 19:16
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    @jamesqf DFV had been saying since Q3 2018 that he believed GameStop's fundamentals were sound, with analysis. – chrylis -cautiouslyoptimistic- Feb 01 '21 at 21:16
  • @chrylis-cautiouslyoptimistic- Deutschen Fibromyalgie Vereinigung? Democracy for Virginia? Deutscher Fußball Verband ? Domestic and Family Violence? – RonJohn Feb 01 '21 at 22:29
  • @RonJohn DeepFuckingValue, the Redditor who kicked off this entire chain of events. – chrylis -cautiouslyoptimistic- Feb 01 '21 at 22:36
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    @chrylis -cautiouslyoptimistic: Yeah, and there are a bunch of people who apparently believed that Trump won the election, and were willing to act on that belief. People are capable of believing all sorts of things that have no discernable connection to objective reality. – jamesqf Feb 02 '21 at 02:54
  • @JimmyJames shorts would win everything. The longs can continue buy and hold and their shares will be worth close to zero as there is no future where capital is returned to shareholders, which is the purpose of a corporation. Gamestop has to recapitalize without bankruptcy for the longs to have an asset worth something upon dissolution. – CQM Feb 02 '21 at 04:03
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    @CQM Do shorts not need to repay shares of bankrupt companies? Does the lender write them off? – user253751 Feb 02 '21 at 09:43
  • @CQM Yes that's the conceptual idea but I'm talking about the mechanics. I'm pretty sure you can continue to hold shares for a bankrupt company. And the price doesn't drop to $0 if people continue to purchase. What would prevent the WSJ crowd and their bandwagon from continuing to push the price up and continue the squeeze? – JimmyJames Feb 02 '21 at 14:39
  • @JimmyJames if the company shares are still tradable on a market, nothing prevents them. the WSB (or WSJ lol) crowd can trade them at any price, it is just that other holders will try to get out of their positions. For example, with Gamestop, Robinhood users were only passing around like 5 million shares, helping dictate the price (causing price discovery) for the institutional holders who own 30 million or so shares. Any of them could always sell and would be a much greater supply than the demand, so there are a lot of paths to the expected outcome of shares representing company value. – CQM Feb 02 '21 at 16:52
  • @CQM OK, that all makes sense and I get that when you have a number of players, someone will cave but in the short-squeeze situation, you could try you stock in a worthless company and get some pennies on your dollar or if a bloc can hold the price or even push it up, force the shorts to cover and make a profit. It seems like a bit of a prisoner's dilemma where the longs all make more if they hold the worthless stock and all lose when someone gives in. – JimmyJames Feb 02 '21 at 17:16
  • @JimmyJames the reason it's not really a prisoner's dilemma because there are so many external parties to the prisoners that aren't constrained by them. Gamestop can create and sell more shares, increasing the total supply and recapitalizing a little bit but crashing the price (the same as the large institutional investors selling), and anyone that actually believes in Gamestop has to trust management to still do something relevant to the market which is still unproven and can fail. Executives can just give themselves bonuses with the proceeds too. – CQM Feb 02 '21 at 17:21
  • @CQM So in the situation where the company is worthless but the stock price is being supported by a short-squeeze, why would the management (who are also stock-holders) choose to help the shorts and make the stock worthless? How does that square with their obligations to the stockholders i.e. the owners of the company? – JimmyJames Feb 02 '21 at 18:21
  • @JimmyJames the corporation balance sheet is more important than random speculation in the secondary market, the book value is the true value of the shares, and the revenue opportunities are the future value of the shares. Management's obligations are to the corporate entity, not gains and losses in the secondary market. Selling more shares to shore up the corporate balance sheet and the using funds at the discretion of the appointed executives is just share dilution. I think your questions require demonizing short sellers, which will limit how you perceive market function and purpose. – CQM Feb 02 '21 at 18:59
  • @CQM " Management's obligations are to the corporate entity, not gains and losses in the secondary market." I don't know what you mean by this. The shareholders are the owners of the corporation. This is the most basic concept of a corporation. – JimmyJames Feb 02 '21 at 19:34
  • @JimmyJames there is a primary and secondary market. the corporate entity only priority is the primary market. this is where shareholders of the corporation originally were created and where those shares are initially sold to those shareholders. trades that happen from those shareholders to different shareholders are that individuals' responsibility and not the management's priority. Like I said, management's priority will be about what can happen in the primary market, focusing on the book value of the shares by nature of the balance sheet, & using the balance sheet for revenue opportunities. – CQM Feb 02 '21 at 19:40
  • @CQM That's complete nonsense. There are plenty of resources on the concept of Shareholder_primacy but you can start with Dodge v. Ford Motor Co. – JimmyJames Feb 02 '21 at 19:43
  • @JimmyJames a 100-year old STATE-level supreme court ruling might convince college undergrad business majors and armchair devil's advocates, but it is not a strong argument. That wiki article also said the concept was "shareholders" vs "STAKEholders" which is not at all contradicting what I said at all. Primary market shareholders are still shareholders. The gains and losses of people trading shares at arbitrary revenue multiples has nothing to do with anything. It's too bad you have determined not to accept how I describe that reality, pick a source you respect that tells you the same thing – CQM Feb 03 '21 at 06:43
  • @CQM I said that's where you can start. There are many more articles on this. For example try: What Is Shareholder Primacy?: Where are you getting your idea that shareholders aren't the owners? What evidence of your claim can you present. It makes no difference how a shared (legitimately) was obtained. It represents a potion of the ownership of the company. How do you think hostile takeovers work? Can you show a single reputable source for your claims? – JimmyJames Feb 03 '21 at 14:26
  • @CQM I also have a graduate degree in this area from an accredited university. So, no, I don't believe your fantastical nonsense. But that doesn't really matter, because facts are facts and I believe arguments stand on their own merits. I didn't "pick a source" to back up my view, I can't find anything that doesn't. 'Stakeholders' aren't owners and common shares convey ownership of a company. But feel free to show some source saying it's lizard-aliens or whatever it is that you believe. – JimmyJames Feb 03 '21 at 15:26
  • @JimmyJames shareholders are owners and I am using this synonymously. the root of your discussion is misunderstanding what I said and what distinctions I made. – CQM Feb 03 '21 at 19:17
  • @CQm "Management's obligations are to the corporate entity, not gains and losses in the secondary market." Which you then followed up with a bunch of minutia about primary and secondary markets suggesting there's some inferiority to that market. And I just noticed something about demonizing short-sellers which I have not done in any way. You are having a debate with a figment of your imagination it seems. – JimmyJames Feb 03 '21 at 19:24
  • @CQM And the whole digression began when you denied that the company management has a fiduciary responsibility to the owners of the company which we've now established are the stockholders. While some people might argue that is not (or should not) be the absolute case, from a legal and practical perspective, the shareholders get the final decision on that, they, through their voting rights, have control over the corporation. – JimmyJames Feb 03 '21 at 19:33
  • @JimmyJames shareholders are owners and I am using this synonymously. let me know if you would like me to clarify that I believe that for a third time after your next two part synopsis. – CQM Feb 03 '21 at 19:36
  • @CQM How does "Management's obligations are to the corporate entity, not gains and losses in the secondary market" square with shareholders are the owners and the management has fiduciary responsibility to them. More specifically for the scenario I described, how does issuing more shares in a company that has decided to cease operations, let shorts off the hook and destroy remaining stock holder value square with that responsibility? – JimmyJames Feb 03 '21 at 19:44
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As an analogy, how does share price rise (or fall)? If there is an excess of buying volume that takes out all of the selling volume at current price, price moves up to the next order on the order book. The greater the buying volume and the more times this occurs, the larger the share price increase. OTOH, if a large buy order comes in and is met with a similarly large amount of sell side orders, share price goes nowhere.

Now suppose you find a stock where the short interest is higher than 50% and you and others attempt to buy at least 50% of the float. If opposing shorters sell an equivalent amount, price goes nowhere and your cabal has a lot of money invested as well as a lot of money at risk. What happens if instead, someone with deeper pockets decides to meet your buying with more shorting volume than you have bought? Rut oh.

The point is that it's not that simple or riskless to just find a heavily shorted stock and buy shares in order to create a short squeeze and thereby profit.

Bob Baerker
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  • So are you say the solution for a short position in a over-shorted stock is to short more? The hedge-funds clearly have 'deep pockets', why didn't they do that? – JimmyJames Feb 01 '21 at 19:21
  • @JimmyJames: Shorting to solve being over-shorted is a kind of cross between martingale betting and chicken. – Brian Feb 01 '21 at 23:09
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    @JimmyJames they may very well have done that, it's commonly termed "doubling down". If you think being short is a good trade, then you may very well decide getting shorter as it rallies is an even better trade. On the other hand some of the short funds may have closed out early, maybe even got long for a while and intend to get short again at much higher levels. Only time will tell who made the correct call(s) - clearly we're aware of a couple who didn't. – David Waterworth Feb 02 '21 at 01:08
  • This answer seems flawed. Unlike writing options, shortselling requires an availability of shares to borrow. And even if those are available, they can come at a cost. IIRC, for GameStop that price went up to a dollar per day. Remember, that's a fee paid by the shortsellers to those in long positions. If you short-sold GameStop at $20, you have 40 days for GameStop to file bankruptcy. – MSalters Feb 02 '21 at 08:04
  • @MSalters - You statements make no sense. What does the fee going up to a dollar per day mean? Per share? Per 100 shares? (The actual daily fee is the borrow rate times stock's close divided by 365 and it changes daily since the rate and stock close change daily). And short selling at $20 and having 40 days for GameStop to file bankruptcy also makes no sense. You can keep a short position open as long as you can meet the minimum margin requirement (30% unless the broker normally requires more or increases it as some did last week). – Bob Baerker Feb 02 '21 at 12:48
  • @BobBaerker: That fee is what you pay per share, not per 100, And I already quoted it as a daily fee, not a yearly fee, precisely because it was fluctuating. You can of course keep the position open past 40 days; you'd just have to pay $25 if you keep it open for 50 days at $0.50 per day. That wouldn't be wise when you only got $20 from the short sale, but the fee wasn't that high at the time of sale. The fee went up even faster than the stock price itself went up. – MSalters Feb 02 '21 at 13:35
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    @MSalters - Your understanding of the borrow fee is totally wrong. A $20 short generates a $2,000 credit. If the borrow rate is 0.50 that is annual percent not dollars. The borrow rate for $2,000 is $2.74 per day ($2,000 * .50 / 365). Based on your incorrect concept of postulating how long you could keep a short position open, though it is not possible, if the share price remained at a constant price of $20 and the borrow rate did not change, you could keep the short position open for two years (50% ?). The reason that shorts cannot be maintained is the margin requirement not the borrow fee. – Bob Baerker Feb 02 '21 at 14:11
  • @BobBaerker: If the borrow rate is 0.50% annually, it indeed works out to $0.00274 per day per share. If the borrow rate is $0.50 per day per share (182 times higher), that works out to an an annual percentage of 91%. That's just basic math. And with GME's volatility over the last few days, you definitely did not pay 0.50% annualized over the historical $20 price. – MSalters Feb 02 '21 at 14:17
  • Borrow rates are not quoted in dollars per day. It's a percentage number. The average borrow rate for GameStop over the past 6 days is 55% and for yesterday, it was was 27.8%. Your hypothetical numbers for GameStop are grandiose. – Bob Baerker Feb 02 '21 at 14:38
  • @DavidWaterworth I get the idea of doubling-down and in normal situations it's clear how that can work. This is not a normal situation. As an analogy, there's a strategy of doubling your bet at the roulette table every time you lose on black and with sufficient capital, it would generally work if it weren't for table limits. That's the interesting part of this for me and I think part of what the OP is getting at. What is the collective table limit for shorting? If the problem is that a stock is 'over-shorted', it needs a little more explanation to get to the solution of 'short more'. – JimmyJames Feb 02 '21 at 20:11
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"Is there a reason this wouldn't work?"

Yes; there is nothing magical about 100%.

Let's imagine a company with a float of 100 shares. Investor1 through Investor6 each lends 10 stocks to shortSeller1 through shortSeller6, who sells that stock on. The short to float ratio is now 60%.

You come along and buy 50 shares, intending to hold to push the price up. There is 50 shares left floating. shortSeller1 covers his position buy buying 10 stocks and returning them to investor1. - Investor1 has no particular desire to keep the stock long term so there is still 50 shares left floating.

Taemyr
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