5 ETFs Primed To Surge On A Short Squeeze
German automaker Volkswagen briefly rocketed to become the most valuable company on earth in a single day. Another stock soared from around $9 per share to over $170 per share in under a year.
These crazy bullish moves wiped out a wide swath of investors; while a savvy minority made fortunes during the same timeframe.
Shares, in both examples, were heavily shorted as many investors were betting on the stock to continue lower. However, bullish news took the shorts by surprise, resulting in the infamous short squeeze.
What Is A Short Squeeze?
A short squeeze occurs when a stock’s outstanding shares are comprised of a significant percentage of short positions. When an unexpected bullish change occurs, the shorts hurry to cover their positions by purchasing back shares.
#-ad_banner-#The resulting buying pressure rapidly pushes the share price higher while trapping the shorts. The climbing price forces greater numbers of short positions to cover, creating a vicious cycle of massive upside momentum. This punishes short sellers while rewarding those few lucky or smart enough to have taken on long positions.
How To Locate Possible Short Squeezes
The way to find potential short squeezes is to scan and rank stocks by their short interest ratio.
Short interest is the number of shares investors have shorted. The short interest ratio is the proportion of the average daily trading volume of the stock held as short interest. It reveals how many days it should take for all the shorts to be covered if the stock’s price rises unexpectedly.
All things being equal, the higher this number, the more powerful a potential short squeeze.
Five ETFs With High Short Interest Ratios
5. SPDR S&P Biotech (NYSE: XBI)
This ETF is higher by over 30% this year, but it is also the fifth-most shorted ETF on the market, with just under 66% short interest. Despite the outperformance of the sector, investors are extremely nervous in the uncertain political and regulatory environment.
XBI consists of 99 stocks, with Clovis Oncology (Nasdaq: CLVS) as its top holding with a weighting of around 3%.
4. SPDR S&P Oil & Gas Exploration & Production ETF (NYSE: XOP)
Falling 24% in 2017, this ETF took fourth place on the most shorted list with over 98% short interest. Oil and gas prices have plunged on strengthening U.S. production and 2017 highs in OPEC exports.
Investors believe that prices will continue to fall and have heavily shorted this ETF to ride the move lower. The ETF consists of 63 stocks, with Rice Energy (NYSE: RICE) boasting the heaviest weighting at just under 3%.
Given the current geopolitical climate, anything can happen in this volatile market, setting up an ideal short squeeze entry.
3. SPDR S&P Retail ETF (NYSE: XRT)
The retail sector has been suffering and this ETF shows it, trading lower by 12% this year. Investors agree that retail will move lower, carrying 103% short interest in this retail based ETF.
Wait a minute! How can short interest be greater than 100%? It happens in ETFs due to the way they trade. Short interest above 100% is not even an absolute signal of all the shares being shorted.
ETF issuer State Street Securities explains it this way, “By taking a closer look at how ETFs trade and their ownership chain, we can see why high short interest in an ETF is not an automatic warning sign of fund closure. Let’s say Buyer 1 lends 100 shares of XYZ ETF to Borrower 1, who then immediately sells them short to Buyer 2. Ownership of these shares could temporarily appear on the account records of all three investors, creating the illusion that 300 shares exist.”
It is also helpful to understand that rather than shares, ETFs are traded in units. Unlike stocks, these ETF units can be created or destroyed in response to demand. This is another reason short interest can move above 100%.
This particular ETF is based on brick and mortar retailers, with Sears as its top holding with a 1.3% weighting. Online retailers have severely hurt traditional retail operations, and this trend shows no signs of ending. I have to admit, the consensus shorts may be right on this one!
2. VanEck Vectors Semiconductor ETF (NYSE: SMH)
Taking second place with a short interest of nearly 128%, SMH is higher by over 18% this year. It is comprised of just 26 stocks, with Taiwan Semiconductor alone comprising over 12%.
It appears investors are piling into the short bus in this ETF due to capital outflows from it. I believe this is a temporary situation and the swelling market for memory chips will continue to fuel demand for the sector. Therefore, I like this ETF as a powerful short squeeze candidate.
1. ProShares Short VIX Short-Term Futures ETF (AMEX: SVXY)
The most esoteric ETF on our list is also the number-one shorted ETF on the market. It boasts short interest of over 153% and is a bet on volatility decreasing further in the S&P 500. It is tied to the CBOE Volatility Index and is higher by 76% this year.
Risks To Consider: Remember, the market can remain irrational longer than you can remain solvent. High short interest ETFs can continue to drop without a short squeeze ever occurring. Always do your research and use the potential of a short squeeze as just one factor in your investment decision making.
Action To Consider: Check the short interest before buying or selling a stock or ETF and always be ready for a short squeeze in highly shorted issues.
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