Short Squeeze 101

For those of you who don’t know what a short squeeze is it’s when huge demand and a lack of supply cause the share price of a company to increase tremendously.  Short sellers are investors who sell a stock and hope to buy it back at a lower price so they can pocket the difference.  In other words, they profit when stocks fall in price and suffer losses when shares rise.   The short squeeze phenomenon occurs when short sellers need to cover their positions (aka buy back the shares they borrowed) and are forced to pay higher and higher prices in order to do so.  This happens most often in stocks that are heavily shorted and have a small amount of outstanding shares.

What happened today with VW is a classic short squeeze.  Major market player’s had been shorting VW shares for a while now, believing that they were overvalued and destined to fall.  These short sellers were taken to the cleaners this morning when Porsche announced that they’d be purchasing an additional 30% of VW’s outstanding shares (Porsche already owns 40% of VW).  Upon the announcement buyer’s snapped up shares of Volkswagen causing short seller’s to panic and buy back the shares they sold short.  The problem was that VW doesn’t have a very large float and the short sellers were forced to pay higher and higher prices to cover themselves.  VW’s shares finished the day up 82% and probably caused a couple hedge fund managers to lose their lunch.

For a more detailed account of the Volkswagen short squeeze check out this article.