I remember a couple of years ago, when I started really learning the ropes, I would always hear about this thing called a "short squeeze." These fascinated me to an incredible degree, and I actually spent quite a bit of time trying to "play" them ahead of events such as earnings reports, conferences, and so on. This would involve me taking a look at a list of highly shorted names, figuring out the odds that the short sellers may actually be "wrong," and then going for it. Tesla Motors (NASDAQ:TSLA) is a prime example of what happens when a short squeeze happens in full force.
The Mechanics Of A Short Squeeze
For those of you unfamiliar with the notion of short selling, it is the precise opposite of "going long" or "buying" a stock. Instead of purchasing shares of a company believing that they will rise, the short seller borrows shares from people who are long the stock, sell them and pocket the cash, and then hope to buy back and return the shares for a lower price at a later time.
Let's work an example. Say that Tesla is trading at $50, and you short 1000 shares. This means your broker lent you 1000 shares, which you promptly sold and pocketed $50,000 for. If the stock goes down to $40, then you can buy back the 1000 shares and pocket the $10,000 difference. Win, right? Sure, but the knife cuts both ways ...
Say that you short those 1000 shares and - gasp! - the shares rocket up to $70 a piece. You are now on the hook for $70,000 worth of goods despite the fact that you sold those same goods for $50,000. Yikes!
It gets worse, though. See, the kindly broker who lent you the shares wants to make sure that he gets his money back. If the losses get too steep relative to your account value on the position, your brokerage will force you to pump more money in to back the short, or they will sell off your other positions and force you to cover.
That's what's happening with Tesla, but this isn't an ordinary squeeze ...
Elon Musk Owns A Bunch, Much Of Float Shorted
This is a supply/demand problem for the short sellers. Elon Musk owns 27M shares, or roughly 24% of the shares outstanding (hint: he's not selling a darn share, either - why would he?). Further, roughly 27M shares are shorted as of the last read, which means that this is a crowded trade. 24% of the float is short, 24% is owned by Elon Musk, which means that there's significant demand while supply remains heavily constrained.
Margin calls and fear of margin calls induces panic buying. This is a positive feedback loop that will keep driving the share price significantly higher since so many shorts need to cover, and so many prospective longs, encouraged by the latest results, want to hop on board.
In short (pun intended), shares are probably going much higher. There will be a time when shares get so overextended that it'll be a good short, but it is nowhere close to that time. In this hyper bull market with liquidity abound and with Tesla shares in short supply, it would be suicide to try to fight this trend. So don't. $100 will be here before you know it.