It's a concept which I feel is quite simple. Sirius XM's (SIRI) roughly 414 million shares short are a debt which must be repaid at some point. For example purposes, at the time of writing one of my more recent articles, Sirius XM: 414 Million Shorts Can Be Wrong, I used a recent share price of $3.20 per share to arrive at the $1.325 billion total.
Of course, as with anything, things behind the scenes may not be so simple as they appear. I make this quite clear within the article linked above when I state such things as the following:
So why do these shorts keep piling on? Or kicking the can down the road, as Apple puts it? It's a question that is likely not easily answered, but can become a bit more clear when one understands that this position is made up of different types of shorts.
Short positions can be part of larger strategies, and not all short positions are simply "naked" with no hedge or cover. So why do I insist that these short positions are "wrong" and that these short positions provide the entire position as "buying pressure"? Let's take a look.
The way I look at 414 million shares short? That's $1.325 billion worth of guaranteed buying pressure at $3.20 per share. The higher the share price goes, the higher this amount rises. The higher the short interest, the higher this amount rises.
This idea is more easily addressed with a quick explanation of a short position.
For every single short, there is a long position which that short sold to, and a long position which that short needed to borrow from. Thus, the end result is 2 longs per short share.
Why does this happen? Because the individual taking up the short position is introducing a debt into the system. The short has taken cash, with an IOU to pay out 1 share at a later date to the individual the share was borrowed from. This IOU is a guaranteed buy at a later date. The short must cover this debt in all cases at some point. Because of this, it can be expected that all outstanding 414 million shares short as of the reporting period will be covered at some point in the future.
Likewise, if one believes that the share price will increase, then these "shorts" will need to be covered at higher prices. The only way a short position makes money is if it is covered at a lower price, or if the company fails and the stock becomes worthless. Since, in my opinion, both are unlikely scenarios for Sirius XM at this point, I expect that the vast majority of these short positions will be covered at a loss.
Overall strategy does not matter. Only the short.
If the share price appreciates from the point the short takes their position, and the short is covered at a loss, the short was wrong. In the case of a hedging strategy, or where the short position was taken up as part of a more complex endeavor such as shorting against convertible bonds as discussed above, the short position remains wrong even if the overall strategy yields a return. The reason? The short lost money. It's a simple concept and does not need to be made any more complex than this.
You may ask: "But don't the shares underlying the bonds negate the eventual buying pressure of the short positions hedged to them?"
And to that I say, "good question," and "no." You see, a short position is a debt which must be repaid, no matter how it is repaid. Whether it is through a market purchase or if the short is covered through conversion of the bond, then the short is still covered. It's still, in my opinion, buying pressure, even if it is indirectly so. It is still a debt of one share which is being covered. Consider:
On top of this if the shorts are hedged against the bonds, that is likewise a very good thing. Why? Because on conversion the shares from the bonds simply cover the short. That's it. If the holders are not short as they take possession of hundreds of millions of shares they may sell into the market and cause a drastic drop in share price. As a long, you will want a considerable short position pointing to the fact that those bonds are likely hedged.
This is rather important to understand. While much of the short position may be hedged against these bonds, if it is so then the shares have already been sold into the market. The conversion becomes a non event and of little concern if you believe that the bonds are hedged. The future buying pressure caused by the initiation of the short side of the strategy of the bond holders "purchases" these bond shares and cancels the debt of the short in one fell swoop. If this short were not present, that share would be free to be sold into the market.
Future buying pressure, even if hedged? You bet. All 414 million shorts, $1.325 billion at a $3.20 share price, are debts which must be repaid.
And what of the bond holder? Doesn't he "win" because he was able to collect interest on the bond and cover his capital outlay by shorting the shares? Absolutely. But he would have won more had he not initiated the losing short play and simply taken possession of the shares at a much higher price later on. While the "strategy" wins, the short part of the strategy clearly loses.
And this is why I say these shorts are wrong, and likely will continue to be wrong. I expect the share price of Sirius XM to appreciate over time as the company grows, and because of the issues discussed within my articles. Hedging may limit risk, but it can also limit reward. If part of the hedge includes a short position, I will expect that part of the strategy to continue to lose.
Other than short-term trades, it has been time to be long Sirius XM since 2009. I don't see that changing for the foreseeable future, and my advice to shorts remains the same. Cover now. Yesterday's opportunity was $2.97. Today's was $3.05.
Tomorrow's? I doubt it will be lower, and I wouldn't be surprised if Sirius XM was ready to move up again very soon.
The largest type, in my opinion, is one, which is hedged to the outstanding convertible notes. These notes are convertible into shares and because of this, a note holder can and usually will short the underlying stock to get his or her capital back. After this they are free to collect the interest, and the cash is free to be used elsewhere. Once they've shorted, they can't lose anything except future gains because the notes provide a hedge against the short."
Disclosure: I am long SIRI.
Additional disclosure: I am long SIRI Jan 2014 $2 calls.