("For a bear to eat, there must be fish in the river." - a Wall Street proverb I just made up. Image by Carl Chapman from Phoenix, USA - Driving To Alaska, CC BY 2.0, source.)
By Mike Taylor
Seeking Alpha proudly publishes short ideas - analysis pieces that make the case for why a stock is overvalued and should trade lower. Although we get many interesting short ideas every day, authors often overlook an important component of the short investment case - the availability of shares to borrow. Because borrow availability greatly affects the feasibility of a short idea, it's important to include such information in short idea articles.
Quick refresher on short selling. Short sellers follow a process that looks like this:
- Identify an overvalued stock.
- Through a broker, borrow shares of that stock from another investor who owns the shares.
- Sell the borrowed shares to another investor.
- Close the trade by buying back the shares and returning them to the investor who owns them.
- If the share price is lower when the trade is closed, the short seller will have profited by selling at a high price, then buying at a lower price (an inversion of the long investor's "buy low, sell high" process).
Critical to this process is the second step - finding shares to borrow. If there aren't shares available, or there aren't many, it will be difficult to execute the trade, even if the investment case is valid. This makes it very important to include borrow availability in any short investment idea, and that's why we strongly encourage such information in any short Top Idea article. (We'll save another consideration, put option prices and liquidity, for another article.)
Fortunately, you can check share borrow availability at Interactive Brokers to get a sense for the market. Clicking that link brings you to a search form. (Update: Although this won't necessarily give you the whole picture of borrow availability -- see comments below -- it can give a sense of how easy or hard a executing a short might be.)
From there, you can look up a ticker. I've selected Netflix (NFLX).
Clicking "Check Availability" opens a popup showing the number of shares available to borrow. In Netflix's case, there are more than 10 million shares available. At $365 a share, there's billions of dollars in available short exposure to Netflix.
Meanwhile, take a look at 22nd Century Group (XXII). Not to pick on them, but they're a popular short candidate on Seeking Alpha and elsewhere, and they're simply a smaller company. This limits the borrow availability.
With 20,000 shares available to borrow and a share price of $2.21, 22nd Century has only about $44,200 in available short exposure. This limits the feasibility, and the potential profitability - of shorting the company.
As you can see, a great analytical perspective isn't the only thing you need to implement a short idea. The market also has to make shares available to borrow in sufficient quantity. After all, if there aren't any shares available to short, investors will have a lot of trouble executing trades and profiting - even from very strong ideas.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.