The Market Mechanics of Short Interest

In this segment of “The Morning Show” on Motley Fool Live, recorded on Dec. 13, Fool Director of Small Cap Research Bill Mann, Senior Analyst Jim Gillies, and Advisor Jim Mueller discuss how short interest is used in the market.

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Bill Mann: AMF, the bowling company, Brunswick (NYSE: BC), whatever. If Jim Gillies goes and says I want to buy a million shares of AMF. It doesn’t matter. I’ll pull something else by random if it’s not actually publicly traded anymore. We use Keweenaw Land Association (OTC: KEWL) ticker KEWL. Yes, that was a northern Michigan reference, if Jim Gillies goes out and says, I want to buy a million shares of the Keweenaw Land Association ticker KEWL, his broker could say, sure, I’ll do that. What the broker does is essentially delivers to Jim a million shares and then it’s got two days to go and find them so every time you make a transaction, even if for a split second, the broker short their shares, until it finds them. That’s the market mechanics. You got to be a little bit mindful, their short squeezes do exist. Usually, a much better way to find companies that are squeezable is to look at what the rebate cost is, that is the cost to be short, and that is what will tell you what the actual pressure is.

Jim Gillies: How hard they are to find.

Mann: How hard they are to find as a short. That is a much better number and before you ask me where I find this number, it’s really hard.

Gillies: You generally have to get a market quote from your broker.

Mann: You’ve got to get a market quote from your broker, there are things that aggregate it.

Jim Mueller: Just like with borrowing anything else, you have to pay interest on whatever you borrow. If you are short a company, you’re paying interest to whoever you borrowed from the broker or whoever you borrowed from?

Gillies: Yeah. That was another thing with the whole Tesla (NASDAQ: TSLA). Tesla was super easy to borrow. You could short it if you wanted to, and it was less than 1%. Compare that to like some of these other smaller companies that Bill talks about where you’d see cost to borrow 20, 30%, or higher. Well Fools, how confident are you in your short thesis? If you have to pay 30% to borrow. I promise you, I’m not going to pay a 30% cost to borrow to short something because am I confident I’m going to make more than 30% because my first 30% is gone. That’s my cost of borrowing it. Nope. I’ve never been that sure of a short thesis in my life and probably never will be.

Bill Mann has no position in any of the stocks mentioned. Jim Gillies has no position in any of the stocks mentioned. Jim Mueller, CFA owns Brunswick. The Motley Fool owns and recommends Tesla. The Motley Fool recommends Brunswick. The Motley Fool has a disclosure policy.

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