How to make money with a short squeeze?

Original link: https://blog.forecho.com/short-squeeze.html

introduction

A short squeeze is an investment strategy in which the aim is to buy stocks to force short positions out of them, thereby pushing up the stock price. Short squeeze is an investment strategy with high risk and high return. Its risk is that if the short position is not closed, the short squeezer will face huge losses.

This article will introduce the principle of short squeeze and how to make money through short squeeze.

What is short selling?

Before we talk about short squeeze, we need to understand what is short selling? Short-selling is an investment strategy. When you are short-selling a certain stock and expect its stock price to fall next, then you can make money by short-selling.

There are two ways to go short, one is to buy put options and the other is to sell stocks directly. We only discuss the latter here.

To short stocks, you can directly close your position at a brokerage to sell stocks, that is, borrow stocks from the market, and return the stocks in the future. During this process, the brokerage will charge you interest until you return the stock.

What is a short squeeze?

A short squeeze occurs when the price of a heavily shorted stock rises rather than falls. For example, a company’s stock is expected to fall, but receives a major piece of good news, and the stock price soars.

In this case, short sellers would face huge losses because they would have to buy the shares they originally borrowed on the contract expiration date. Short sellers will have to buy shares to cover their positions, pushing up the stock price.

Therefore, the key to a short squeeze is good news. This news can be the company’s performance, or a major event of the company, such as an acquisition, or a major cooperation of the company. Put short-term pressure on the short-term, thereby forcing them to close their positions.

The Pros and Cons of a Short Squeeze

There are pros and cons to participating in a short squeeze. Let’s look at the pros and cons of this investment strategy:

advantage

Theoretical Unlimited Gains: The biggest draw of a short squeeze is that short sellers must buy back the stock they shorted at the contract’s expiration date, regardless of the price. This means that if a short squeeze does occur, there is no upper limit to the total profit you can make from the trade as an investor.
Less risky for investors than for short sellers: If you invest in a stock hoping for a short squeeze and it doesn’t, the most you can lose is the amount you invested. Short sellers, on the other hand, can face losses of over 100% and may be subject to margin calls and interest. Forecasting a short squeeze becomes even less risky if you buy long-dated options because you can choose not to exercise the option if the stock price does not rise as you expect.

shortcoming:

Can lead to loss compounding: While getting a short squeeze right can lead to realizing almost unlimited profits, getting caught up in the hype of a short squeeze can also cost you money. For example, in the current GameStop squeeze, the price of GME stock peaked at approximately $347 on January 27, 2021. Just one week later, on February 3, GME stock averaged $92.41. This wouldn’t have been a problem if investors had bought GameStop stock around October 2020 when it was trading around $14, but amid the hype and excitement surrounding GME in January, many investors were buying at $300 or more buy. Those who still hold these investments may have lost hundreds or even thousands of dollars with little hope of recovery.
Could make you own a stock with shaky fundamentals: As we’ve said, sharp increases in stock prices associated with short squeezes usually have little to do with the underlying company’s fundamentals. This means that if you miss the exit point of the short squeeze, holding the stock for the long term may not be a viable option. Especially considering that heavily sold-off stocks are often associated with financially failing companies.

forecast short squeeze

Predicting the timing of a short squeeze can be challenging. Here are some indicators that can be used to predict when a short squeeze is coming:

High Short Interest Percentage: The more investors or investment firms who are short a particular stock, the more competition there is to buy back that stock at maturity. As more investors take short positions on an asset, interest on that asset rises as demand increases. More investors shorting a stock may make shorting more effective.
High Short Interest Ratio: A stock’s short interest ratio is calculated by dividing the stock’s current short interest by its average daily trading volume. The short interest ratio tells you how long it takes on average for a short seller to close out their current position. The higher the short interest ratio, the more likely a short squeeze is, as competition to buy back shares surges.

see an example

GME 2021-01-25 was squeezed short. At that time, retail investors united to form institutions. The money of retail investors came from the outbreak of the Fed, so they didn’t care. In addition, it should be noted that the short-squeeze market is not suitable for long-term holding, because the fundamentals of the short-squeezed stocks are not good, so when the short-squeeze occurs, it is necessary to ship in time.

Should I be involved in a short squeeze?

With the possibility of unlimited profits, participating in a short squeeze can be both exciting and profitable, and looks like a good strategy. However, short squeezes can also pose risks for both short holders and sellers. If you decide to engage in these riskier moves, remember to never invest more than you can afford to lose.

how i got involved in a short squeeze

It’s so hard to bet on breaking news, so I think betting on earnings day is a good bet. There is a characteristic of stocks that are severely shorted. If there is good news, the stock price will skyrocket. For example, the stocks I have recently observed and participated in are:

NVAX: Shares soar 27% on better-than-expected earnings
CVNA: Shares soar 26% on better-than-expected earnings
UPST: Shares soar 36% on better-than-expected earnings report

Of course, there are also financial reports that are not good, and then continue to fall, but if it rises, it usually rises sharply. So I think it is a good choice to buy a doomsday call before the financial report. Although the IV value of the option is relatively high, I think it is still worth it.

Pay attention to the high short interest percentage. When the short interest percentage of a certain stock exceeds 30%, I will pay attention to this stock, and then look at the financial report day. Before the financial report day, I will buy a Doomsday Call as a lottery ticket. This money must be done well Going to zero, so don’t invest too much.

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Summarize

A short squeeze is a high-risk investment strategy, but if you can correctly time it, it can pay off hugely. It is a good choice to choose a short squeeze on the financial report day. In addition, it should be noted that the fundamentals of the stocks that are short squeezed are not good, so they should be shipped in time when they are short squeezed.

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