This has been quite an eventful year so far in the world of economics. With the emergence of COVID-19, we would soon notice stock value after stock value plummet. A wide variety of businesses were closing, so was this economic decline really a surprise? So far in 2020, the stock market has been extremely volatile; more so than usual, in fact. This makes it rather difficult for investors to know what to expect.
*Note: The content of this article is for educational purposes only and is not to be construed as financial advice.
Indeed, this begs the question of how investors can gauge market sentiment. The solution for this predicament comes in the form of the ‘short selling’ strategy.
In this period of economic uncertainty, many investors are wondering which stocks they should short. While they cannot guarantee amazing results, they still may be looking out for stocks that they should keep a close eye on.
What does short selling mean?
‘Short selling’ – or ‘shorting’ – is a popular strategy in investment or trading. The core idea centers on the speculation of the decline in a stock or other securities price. It is an advanced method that only traders and investors with extensive experience should utilize.
Traders will often use short selling as a means for speculation. Investors and portfolio managers, on the other hand, will likely use it as a way to hedge their risk. Specifically, against the downside risk of a long position within the same security or a similar one. Speculation in and of itself possesses the probability of substantial risk. The concept of hedging is a more common transaction, frequently pertaining to the placement of an offsetting position. Doing this will aid in reducing overall risk exposure.
In the short selling process, the opening of a position is triggered by borrowing shares of a stock or other asset. This stock or asset is one that the investor believes will decrease considerably in value by a set future date. In other words, the expiration date. The investor will then sell these shares that they are borrowing to buyers who are willing to pay the market price. Before the return of the borrowed shares, the trader is in the middle of betting that the price will continue to decline. From this, they hope to purchase them at a much lower cost.
Theoretically speaking, there is no limit to the risk of loss on a short sale. This is mostly because the price of any asset has the potential to climb to infinity.
Anatomy of a short
Let’s use a hypothetical scenario as a way to better illustrate how shorting a stock works. Suppose that you are of the belief that Company ABC is overpriced at $50 per share. You decide to borrow 100 shares from your broker and pay interest on the loan. Then, after all of that, you go forward with selling them for $5,000. Time goes by and just as you predicted, the stock price suddenly falls. At $40 a share, you purchase 100 shares for a total of $4,000 before returning them to your broker. In the end, you will walk away $1,000 richer; minus the costs of investment, of course.
Well, that definitely appears to be a very successful short, doesn’t it? However, there is one other thing we should take into account. What if the stock increases in popularity? Let’s assume that the price rises to $60 per share. Alternatively, $6,000 for those 100 shares you need to return. That means that you are out $1,000.
Shorting, to sum up is an admittedly strange type of transaction. You are basically selling something you do not own or possess. According to Ryan Bend, senior portfolio manager of the Federated Prudent Bear Fund (BEARX), the goal is to sell high and then buy low. This is in stark contrast to the common game plan of buying low first and then selling high.
Volatility can lead to a gamble
If you believe a stock will rise, you buy it. It’s that straightforward. But what happens if you are bearish on a company’s prospects and want to make a profit off it? Then this is where short selling comes into play.
Selling a stock short requires you to borrow shares so you can immediately sell them afterward. You need to wait for shares to fall in price before you can buy them back and return the shares to the lender. Ultimately, your profit is the main difference between the price you are selling and the price you repurchase.
Really though, it’s a gamble. However, that gamble could backfire, which is great news for bullish investors. Short sellers provoke losses whenever the stock’s price soars. In addition, time is an enemy when you short a stock due to you paying interest whenever you borrow shares. If your wish is to exit your short trade, then it is imperative that you buy back shares.
As a result, the stock price will go higher. This will likely force other short sellers to cut their losses and lead to a virtuous cycle of buying. That being a ‘short squeeze’.
The recurring rise
For context, a short squeeze is a recurring event in investments and finance. It occurs whenever a stock or another type of asset jumps sharply higher. This, in turn, forces traders who were betting that its price would fall to buy it. In doing so, they will forestall any greater losses. Their mad dash to buy only adds more strain to the upward pressure concerning the stock’s price.
This is why short interest (i.e. how many shares are currently selling short to bet against a company) matters. When you think about it, there is no concrete level. Be that as it may, anything over 10% of the float is worth monitoring. That 10% is the total number of shares available for public trading.
If you are a traditional, buy-and-hold investor who dislikes volatility, then you should avoid stocks possessing high short interest. On the other hand, if you are an aggressive investor, then consider buying these stocks. If nothing else, you should do so in the hope that a little nugget of positive news will spark a short squeeze. The result will be that you could net large returns in a short amount of time.
Seven to short
As British economist, John Maynard Keynes, once said in the 1930s:
“The markets can stay irrational longer than you can stay solvent.”
In a way, what this statement refers to appears to be happening at this point in time. There is a great disconnect that is occurring between the economy and the stock market. The S&P 500 total return is positive in the year when we have a lot going on. Unemployment in the double-digits, a global pandemic, street riots, a rise in geopolitical tension, you name it.
It only makes sense that you choose to short the best stocks in these chaotic times. The market is, of course, quite fickle, and some stocks may stand out from others. Here are a few that have garnered attention recently:
7 Best Stocks to Short
1 – Co-Diagnostics (CODX)
Co-Diagnostics is a company that develops diagnostics technology. One prime example includes its Logix Smart COVID-19 test. Taking the ongoing epidemic into account, it is understandable why Co-Diagnostics shares are going up. In fact, it has gone up an amazing 1,800% year to date in 2020. Regardless, there are some short-sellers who are betting that the rate of the stock’s meteoric rise is much too fast.
In mid-May, Co-Diagnostics would experience a boost following an interesting study. The results of this study found potential inaccuracies existing within a competing test by Abbott Laboratories. Testing accuracy is a recurring issue throughout the health crisis. As such, much larger competitors are instead of developing their own tests. As is, it’s unclear just how efficiently Co-Diagnostics will be able to scale its production to meet massive near-term demand.
Furthermore, the company’s long-term outlook is not all that clear either. Co-Diagnostics possesses about $106.4 million in total short interest. Short sellers are paying an annual 141.8% borrow fee, which according to S3, is higher than any other stock on the list.
2 – Blink Charging Co. (BLNK)
There was a recent surge in the stock price of Blink Charging Co. which is proving to be rather beneficial. It could provide an attractive short entry point. The AI systems of Forbes have the factor scores as the following:
- C in Technical
- C in Growth
- F in Quality Value
- C in Momentum Volatility
These scores have been identified for the company. It is an owner, operator, and provider of services for electric vehicle charging. At this point in time, there is serious competition in this particular space.
For the year so far, the rise in the stock clocks in at 19.05%. The revenues, on the other hand, have been less than spectacular, rising only 2.62% in the last fiscal year. And this is following a 39.24% rise over the previous three years. Earnings per share (EPS) did, however, grow by 98.42% during those three years. So, the company is not without its bright spots. In spite of this, the negative operating income of $(10.38) million in the last fiscal year was bad. It was a worse showing than even three years ago when there was an operating income of $(7.12) million.
EPS is still in the negative despite the growth in percentage, sitting at a $(0.37) loss. It is important to note that this is not dreadful as three years ago EPS was $(25.95). Moreover, return on equity (ROE) was stuck as a pretty bad -82% last year.
3 – Tetraphase Pharmaceuticals Inc. (TTPH)
Tetraphase Pharmaceuticals Inc. is a company specializing in biotechnology. The company employs the use of its proprietary chemistry technology in order to create, develop, and commercialize novel tetracyclines. The common use for these creations is for the treatment of life-threatening conditions.
Recently, the stock underwent an uptick of sorts. However, it is down 24.2% for the year and down over 84% in the trailing one-year. It’s one option to utilize the recent rally as a means to effectively short the stock.
4 – Tilray (TLRY)
Cannabis stocks are proving to be quite lucrative for short-sellers. In 2019, they made a killing, and 2020 has proven itself to be on a similar path. This is even as Canadian sales growth continues to lag expectations. In the midst of the worst period of the March sell-off, Tilray shares were down 90% from where it was a year ago. As a result, short sellers went on to rake in huge profits. However, Tilray’s stock price would later increase and is now over 160% since March 23.
Adding to the broad market strength, cannabis stocks are rallying on even better first-quarter earnings. A study from the University of Lethbridge indicates that cannabis has the capacity to help prevent or treat the coronavirus. Despite the big move of the stock during the last couple of months, Tilray still has $175.7 million in short interest. What’s more, short-sellers are starting to pay a large 136.5% fee specifically for those borrowed shares.
Something important to remember is that short sellers are likely skeptical of the Lethbridge study. They believe that Canadian producers similar to Tilray will still struggle with profitability in the near term.
5 – Cardiff Oncology Inc. (CRDF)
Cardiff Oncology Inc. is another company that those looking to short a stock should keep an eye on. According to Forbes, it has factor scores of the following:
- F in Technical
- F in Momentum Volatility
- C in Quality Value
All things considered, the stock has had a banner year, having been able to garner 97.6%. However, the longer-term downtrend appears to be re-establishing itself following a recent gap comparatively higher in May.
Operating income was able to grow by 21.01% during the previous fiscal year. As a matter of fact, there was a growth in EPS, increasing 25% over the same period. In the last three fiscal years, EPS also experienced a surge of 95.67%. This is where the positive points come to an end for this company’s financials. Operating income was an atrocious loss of $(16.68) million last fiscal year. This is noteworthy when you compare it to a $(21.32) million loss in the previous three. ROE is not getting any better, either, with a (189.6)% transforming into a (188.7)% last year.
Some expect revenues to grow roughly 685.71% during the next 12 months.
6 – Aurora Cannabis
This year, Aurora Cannabis shares were at one point trading for as low as 60 cents. To elaborate, this was from a combination of a low cash balance, a high cash burn, and a troublesome outlook for raising capital. Not too long ago, Aurora implemented a reverse stock split, their reason for being to preserve its listing. There was also an announcement of a $250 million equity facility that could reduce shareholders by roughly 30%.
Against all odds, Aurora’s would find a way to come back to life. In the last two months, its numbers went on to soar, effectively doubling since late March. There was a 40% drop for Aurora’s first-quarter cash burn. Management claims that it plans on using only a fraction of that $250 million. Aurora’s recent announcement states that there is a $40 million buyout of U.S. cannabidiol company Reliva.
Short sellers still are not quite onboard with the bullishness. In turn, they are opting to pay a 104% fee on their $386.1 million outstanding positions. That is a truly remarkable aggregate short position.
7 – Hertz Global Holdings
Hertz Global shares are down more than 90% year to date and trading at about $1 or less. However, it is not hard to understand why exactly short sellers are refusing to go away. In May of this year, Hertz would file for Chapter 11 bankruptcy. As a result, the New York Stock Exchange would later announce that the stock’s delisting.
While bankruptcy is indeed unfortunate, it doesn’t always lead to the liquidation of a company’s assets. Moreover, it does not necessarily mean that the company’s equity value will plummet essentially to $0. In the case of short-sellers, they wait in anticipation for $0 in this instance. Hertz already possesses about $19 billion in debt and reportedly has a $356 million net loss in the first quarter. The company’s lenders and shareholders see liquidation as the preferable method of recovery. Specifically, recovering a fraction of their losses. Moreover, it is unlikely that they will allow Hertz to merely revamp.
In short interest, Hertz has about $172.9 million. What’s more, short-sellers are paying an 81% borrow fee in the hopes of there being more downside.
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