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A Surprising Secret in Short Interest Data


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Nasdaq Chief Economist

Short interest data is very different from long data.

Long holdings are disclosed each quarter, on up to a six-week lag, by many investors. The only exception being that once a holder owns more than 5% of a voting class of stock, they are required to disclose their holding within 10 days along with any intentions to acquire the company.

In contrast, short positions are disclosed each two weeks in aggregate. Although that’s more frequent, there is no attribution to funds or investors, even if a single holder has acquired a large short position.

Who are the shorts?

It’s worth understanding first that even though the shorts are not attributed to funds, not everyone shorts stocks.

Before you short a stock, you are required to “locate” a borrower for the security you want to short. That’s so when you come to settle your short, you have a security to deliver to the buyer.

To ensure lenders assets are safe, each borrow is also collateralized. So you typically need to be able to borrow money and to lodge collateral in order to be able to short stocks. That makes it hard for most mutual funds to short, as they are restricted from borrowing.

So it is more typical for hedge funds and banks hedging to short stocks.

Importantly though, hedge fund data shows dedicated shorts make up less than 1% of all hedge-fund assets. So, as we discuss later, most hedge funds are in fact mostly “hedged.”

Chart 1: Very few hedge funds are “dedicated short”

It’s likely, with equity futures trading over $300 billion per day, that futures arbitrage also contributes to short stock positions.

Short interest is pretty stable for index-constituents

When we look at the average short interest, as a percentage of daily trading across all Nasdaq listings, we see that the average level of short interest is surprisingly constant over time, with short interest ranging from four to five days of ADV since 2012 (Chart 2). That’s especially true for Global Market stocks which are typically larger cap and more likely to be members of major index futures or liquid ETFs.

Perhaps more important though, is that during market selloffs short interest actually declines. In fact, the data in Chart 2 show volatility in green with spikes in VIX (circled in red) typically linked to sell-offs. Surprisingly, spikes in VIX are coupled with a local low in short interest (also circled in red).

Chart 2: Short interest is surprisingly constant over time

Average short interest in smaller Capital Market listings aren’t so consistent over time, and in contrast do seem more aligned to VIX levels. However as VIX has stayed mostly low since 2013, (relative) short interest in these stocks has fallen versus levels of shorts in larger cap stocks.

What are the key lessons here?

Some fear that shorts exacerbate selloffs, by adding to shorts just as the market sells off. However, the data seem to contradict that theory. In fact, when sell-offs happen, shorts actually decline.

That may instead highlight that hedge funds are in fact “hedged,” and when VIX spikes they look to reduce risk more generally, reducing both long-and short sides of trades.

Regardless, the stability of average short interest seems to show that most of the short interest has very little interest in the actual direction of the market.

Originally Posted on February 13, 2020 – A Surprising Secret in Short Interest Data

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