Short Squeeze

Lore & Background

Short squeezes result when short sellers of a stock move to cover their positions, purchasing large volumes of stock relative to the market volume. This raises the price of the shorted stock, triggering more short sellers to cover by buying the stock, creating a cascade of purchases and an even bigger jump in share price. Borrow, buy and sell timing can lead to more than 100% of a company's shares sold short. Short squeezes tend to happen with stocks that have expensive borrow rates, which can increase pressure on short sellers to cover their positions.

Buying by short sellers can occur if the price rises to a point where shorts receive margin calls they cannot meet, triggering them to purchase stock. This buying may proceed automatically if short sellers had placed stop-loss orders. Short sellers simply deciding to cut their losses can also cause a squeeze. Short squeezes can also occur when demand from short sellers outweighs the supply of shares to borrow, resulting in failure of borrow requests from prime brokers. This sometimes happens with companies on the verge of filing for bankruptcy.

Reader's Guide

Short squeezes are more likely to occur with listed stocks with relatively few traded shares and commensurately small market capitalization and float. Squeezes can, however, involve large stocks and billions of dollars. Short squeezes may also be more likely to occur when a large percentage of a stock's float is short, and when large portions of the stock are held by people who are not tempted to sell. Short squeezes can also be facilitated by the availability of inexpensive call options on the underlying security because they add considerable leverage.

Typically, out of the money options with a short time to expiration are used to maximize the leverage and the impact of the squeezer's actions on short sellers. Call options on securities that have low implied volatility are also less expensive and more impactful. The opposite of a short squeeze is the less common long squeeze. A squeeze can also occur with futures contracts, especially in agricultural commodities, for which supply is inherently limited.

The sale of naked call options creates a short position for the seller, in which the seller's loss increases with the price of the underlying asset and is therefore potentially unlimited. The resulting upward pressure on the price of the underlying can develop into a positive feedback loop, as call-sellers react to the rising price by buying the underlying to avoid exposure to the risk that its price may rise further.

Did You Know?

• In October 2008, a short squeeze drove Volkswagen AG shares on the Xetra DAX from €210.85 to over €1,000 in less than two days, briefly making it the most valuable company in the world.
• The GameStop short squeeze reached an all-time intraday high of US$483 on January 28, 2021 on the New York Stock Exchange.
• In March 2022, a short squeeze on LME nickel contracts caused prices to rise by around 250 percent, after which the LME halted all trading and reversed many of the trades.