Short sellers are down $ 91 billion in January as GameStop leads a squeeze on stocks they bet against

Short sellers on the ropes – or are they? Short sellers clearly picked the wrong names in January. The GameStop phenomenon – where buyers deliberately target heavily shorted stocks – is just the most recent development in a long line of failed short sellers. But don’t count them yet.

The relentless recovery of the markets has not been favorable to short sellers for many years. Despite all the attention paid to the superstars of short sellers, most of these managers lose money. Equity shorts lost $ 243 billion in 2020, a negative return of 26%, according to S3 Partners.

This month, their performance is even worse. In January alone, they are down $ 91 billion, according to S3.

And while traders often focus on stocks that have made money for short sellers due to being in disadvantaged sectors (ExxonMobil) or exhibiting accounting irregularities (Luckin Coffee and Wirecard), most short films fail.

In 2020, 57% of all short securities lost money. Sixty-eight percent of every dollar bet lost money.

“The biggest enemy of short sellers hasn’t been the Robinhood or Reddit discussion forums, it was the Federal Reserve and the stimulus that pushed most stocks higher. It’s not a market. value, it is a dynamic market, and they [short sellers] are on the wrong side of the dynamic, ”Ihor Dusaniwsky of S3 Partners told me.

Given the defeat of short sellers, it’s no surprise that the dollar value of short stocks relative to the dollar value of the S&P 500 is at its lowest level in several years, according to Goldman Sachs.

At any given time, short sellers typically have between $ 900 and $ 1.3 trillion in short bets in the market, according to Dusaniwsky. This represents about 2% to 3% of the market capitalization of US stocks.

It may seem like a small amount of money, but short sellers play a very important role. They help expose companies whose accounting is perhaps questionable, as was the case with Luckin Coffee and Wirecard last year.

They also provide hedges for long portfolios.

Their most important function may be to provide liquidity. They provide liquidity for the stock market and they provide liquidity to derivatives traders who take the other side of options trading.

This is where the GameStop story comes in. “Shorts provide liquidity at the back of rallies. If you’re a long seller at the top of a rally, shorts are the only ones buying your stock. “, Dusaniwsky told me. “Shorts provide liquidity that many longs no longer provide.”

The shorts certainly seem to be in a difficult position. Peter Tchir, Academy Securities, said shorts are hit with a “two-stroke”: First, the relentless market rise, but second “some traders are aggressively buying silver call options . This tightens the shorts. At the moment, that seems like a working strategy. “

What will happen to the shorts? “The shorts will have to be more comfortable with the losses before they are stopped,” Tchir told me. “And I guess the prices of call options will go up. Movements like [Monday] seem insane without a reassessment of options. It makes me nervous. “

If call option prices do increase, Tchir warns that this could generate false signals for the market. “If call option prices rise, it could force the VIX up, and traders may mistakenly believe that fear is rising. Now might not be the time to be bearish, but it is certainly now is the time to avoid the highly volatile stocks that are chat room favorites. “

Despite all the difficulties, Dusaniwsky laughs when I ask if this is a fatal blow for short sellers.

Not a chance, he told me: “Even as short films are getting killed, new short films are coming, especially in finance and even in the names that have had the biggest hits by blowing up sellers at discovered.”

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