As a former OTC Market Maker, here is a likely explanation as to why Kandi (NASDAQ:KNDI) stock was aggressively knocked down yesterday with no news.
Kandi stock has listed stock options that trade on the listed options exchange. Kandi's stock options always expire on the third Friday of the month. This Friday, the various option levels expire for the month of September (as you can see on the table below) which is the last options period for the third quarter of 2013. Though KNDI normally does not trade a lot of options, this September period is an anomaly. As you can see from the yellow highlighted area on the options table below, the near term, $5.00 "Call" options have an astounding 6,634 "contracts open interest" outstanding. Usually, normal retail speculator investors buy these options which have been available for purchase on the options exchange for some nine months now betting that the stock would close above $5.00 on Sept. 20th expiration day. If it does, then they can "exercise" or "Call" their options by putting up the $5.00, (often they would use margin to do this requiring only $2.50 a share be put up) or they could sell back the options for the premium.
On the other hand, for each option that is bought, some someone had to "sell" these options. It is likely that a large percentage of the options that were "sold" were sold as "naked options". Which means the person or entity who sold the options to the long holder does NOT currently own the underlying shares, but is still required to deliver the shares to whoever exercises the options if the stock closes above $5.00. If he can get the stock to close below $5.00 the naked options short seller gets to keep the entire premium or "in the money" value the buyer paid him at the time of the original transaction. HOWEVER, if the stock closes above $5.00 this Friday, the short seller could have an extreme problem in having to quickly "deliver" shares to the buyer that he doesn't own since outstanding "in the money" options will likely be exercised.
Each options "contract" represents 100 shares of common stock or 663,400 underlying shares in this current case. So what this means is that in addition to the latest reported short position of some 3.4 million shares, and now brokerage firms offering stock loan premiums as high as 90% annualized, depending on how many of those options were sold "naked", there could in theory be as many as 663,000 shares that could be forced to buy stock by next Wednesday in the open market IF THE STOCK CLOSES ABOVE $5.00 ON FRIDAY. If it closes at 5.00 or lower, the short seller gets out of this one "trap" only for the moment. Now I do not believe all of these options are naked short options. Some conservative investors do "sell" options against a long position in stocks. But it would not be unrealistic to see maybe 3,000-4,000 of these contracts representing 300,000 to 400,000 shares having to be delivered on exercise to those who own the options long. And since we know there are effectively no shares available to borrow in a conventional way, forced "buy-ins" could happen to exacerbate a short squeeze.
What adds to the drama, today is the fourth consecutive day, KNDI's stock has been listed on the SEC Reg SHO list as one of only a handful of NASDAQ stocks , (which means it has been in a Fail to Deliver mode for at least .05 percent of total outstanding shares, 182,500, for at least nine business days now) and if it remains on that list for another nine days, even more forced "by-ins" cold happen, irrespective of what happens Friday. It is for this reason; the short seller is desperately manipulating the stock down in hopes of scaring long holders into at least not buying, but wants outright selling.
Yes, it is early in the week, but he knows he has to get this stock back trading in a negative mode in order to be more comfortable that he can get this below $5.00 by Friday. What he attempted to do Monday and likely the rest of the week was/is to "break down" the chart on the stock by having it close each day as close to $5 as possible, even if it means he increases his overall short position with more naked short sales. And for him, even better if he can close it below 5.00. If he does this, he knows it will be harder to get the stock back above $5.00 by Friday.
Now one may wonder; "how can a short seller keep creating new shares to attack the stock if there are no shares left to borrow?" Well, of course some is naked short selling, but a lot is using real shares he purchases in a different account on a fast run-up. He usually does this right after the opening taking the stock to its high of the day early. Depending on how he feels the volume will come out, he might buy a as many as a few hundred thousand shares and take the stock up 4 or 5% quickly buying ahead of the momentum traders who tend to chase it up. Then he quickly reverses his position by taking the shares he just bought and start pounding the bids. This serves him a dual purpose.
- He tries to set up a trading pattern for the rest of the day of lower highs and lower lows. A pattern that disappoints the momentum traders and also might scare out a few long term holders.
- The momentum traders that he chased higher see the quick reversal and sell the stock they bought in a panic helping the shorts cause.
If he runs out of the stock he bought earlier, he just goes back in the market and reloads as he did earlier. But, this strategy only works to a point. And that is why the short interest has gone up almost four fold to 3.4 million shares since it was 750,000 June 1st. Each time he tries this trick, inevitably, some buyers step in to buy his selling and hold the stock. So, aside from a rapid increase in the short position, he has to continue to let the stock go to higher levels to attract new real sellers.
Yes, this is a very big risk he is taking in that his antics are creating an even larger short position right now that will create more problems for him "down the road", particularly if he is not successful in keeping the stock below $5 by Friday's close.
Watching the stock trading Monday, I am confident the short seller has had to sell at least another 200,000 share short. And since there are no shares available to borrow, likely more naked short selling. As discussed, this is the exact thing that has this stock on the Reg SHO list right now; selling stock short without borrowing. Yes, this is illegal, but since history has shown that the penalty for "getting caught" selling shares naked is usually just a slap on the wrist and a small cash penalty a few years down the road, his current concern to avoid a short squeeze next week could cause considerable cash penalty over the next week to ten days.
What could be setting up is a similar situation that we saw in fellow EV maker, NASDAQ listed Tesla Motors (NASDAQ:TSLA) last April in the $30-40 a share area before the sustained move to over $175 a share. At that time TSLA had a reported short of 32 million shares (now 30% less). That sizable short at the time was causing a scramble to borrow shares where reported premiums were being quoted of over 70%. But what makes the situation even more tantalizing in Kandi's case is that Telsa shares never where on the Reg SHO fail to deliver list.
As a former Market Maker and Wall Street pro, as well as an old Marine Corp Viet Nam era Captain, I am telling you the shareholders are in a war that will "take no prisoners". If the stock closes above $5.00 the longs win and we could see a $10 and higher stock in a very short period of time; particularly with all of the news on the beginning of payments on the recently announced China EV subsidies program and the expansion of KNDI's CarShare program which even without subsidies will add at least $50million top line the balance of this year. If the short wins the battle at hand, it could take several months for long shareholders to achieve that goal. Incredible fundamentals are being ignored right now but not for long. Either way the short will lose, but short sellers live from day to day.
As further confirmation of what I am saying above: 15 months ago there was an article written in Forbes about KNDI and options expiration that might help further explain this situation. At that time, the Forbes writer, Konrad, was only talking about 1,018 contracts expiring against a reported short interest of around 600,000 shares at that time. But you get the idea. Here is the link to that article, but I also have copied and pasted the article below the current options table below in case you have trouble accessing the link.
Article from Forbes on-line 15 months ago below
6/15/2012 @ 10:18AM |1,033 views
A Kandi Coco EV
The open interest on Kandi Technologies' (NASD:KNDI) June 16 $2.50 calls is 1,018. With the price at $2.58, these look likely to be executed, and 101,800 shares of KNDI will have to be delivered by Wednesday.
Why is this a big deal? Because KNDI only trades an average of 36,000 shares a day, so if even a fraction of the options aren't covered (i.e. the option writer does not own the underlying stock, also known as "naked" option writing) they will either need to borrow the stock, or buy it in the market. There isn't a lot of stock out there available to borrow (I was recently paid interest to loan mine, so buying will be the only option for some.) That buying could overwhelm the market's normal volume, and send KNDI spiking.
Most of the option holders will have paid a lot more than 8 cents to buy the options, so I don't expect much selling from them until they think they can sell at a profit. People hate to take a loss, especially when a gain is so tantalizingly close.
The stock has been falling recently, but not because of any bad news. Those who read the tea leaves in the Chinese press think Kandi is very close to announcing a deal to sell 20,000 or 100,000 of their electric mini-cars to a municipal rental program, and the option holders almost certainly know that. I think they'll hold their new stock, not sell it and recognize a loss when they think a big announcement is close.
The tide is about to go out on KNDI option sellers. We'll soon see if anyone has been swimming naked.
[Late Add-On, Breaking news this morning in China that Subsidies have now been released.]
Wall Street Journal
U.S. EDITION Tuesday, September 17, 2013 As of 3:41 AM ED
SHANGHAI--China has rolled out a new incentive program for fuel-efficient automobiles to encourage the take-up of environmentally friendly vehicles as the country battles unprecedented pollution.
With immediate effect, buyers of electric cars will receive up to 60,000 yuan ($9,800) in subsidies while buyers of certain gasoline-electric hybrids may get as much as 35,000 yuan, the Ministry of Finance said Tuesday.
The subsidies will be lowered by 10% in 2014 and 20% in 2015 from the current levels, the ministry said.
China offered a similar subsidy program in 2011 and 2012.
Write to Rose Yu at firstname.lastname@example.org
And here is the headline and link to the Official Release posted in China this morning by the Ministry of Finance of the PRC.
Disclosure: I am long KNDI. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.