Short Squeeze

Ever see anyone walk uncomfortably out of the Target changing room wearing something the clothing designer never intended to fit onto that body? Yeah. That would be “squeezing the shorts.”

In Wall Street-speak, the term is, uh, related. Kinda. A given stock has a float of, say, 100 million shares and averages 3 million trade each day. There’s a big hedge fund that’s convinced the company’s cancer-curing drug will actually only turn the users’ toenails bright green. So they short and short and short. Note that short-selling is when an investor is betting that the stock will go down in price. They essentially borrow securities from the brokerage with whom they have set up the short-selling contract. Those shares get sold at whatever price they’re trading at at the time the short sales happen. The hedge fund then waits until the stock falls to its target price, at which point it then buys back the stock more cheaply, delivering them back to the brokerage, and booking what is, hopefully, a hefty profit. But things don’t always work out according to the best laid plans of hedge funders and men.

So Cancer B Gone stock climbs, despite the hedge fund having bet that it would go down. In horror, the hedge fund watches as the stock climbs from 82 to 85 to 90, with the fund all the more sure it's worth 10 bucks a share. After continued shorting of more and more shares, betting on the downfall of Cancer B Gone, the hedge fund wakes up in horror one morning to read The Wall Street Journal headlines, and, uh...the drug actually works. So the CBG shoots suddenly to 200 the next moment, leaving the hedge fund now with an average short sale price of 85-ish per share.

The hedge fund is 115 dollars per share in losses per share, times the 10 million shares it shorted. The loss on this short has wiped out all of the gains for the year the hedge fund had hoped to book. And worse, the stock now has virtually unlimited upside, as cancer curing...really is a thing.

So the hedge fund is squeezed. That is, its short position is squeezed, because it absolutely has to buy back the shares now at the 200+ dollar price, capitulating that it was wrong in shorting it in the first place, and all of its competitors know this fact, as they carefully track the short position on the stock, noting that some 50% of the total shares outstanding were, in fact, short.

So competitive hedge funds will be buying the snot out of the stock for a while, until enough volume in shares transacting passes, so that the hedge funds will have covered their shorts, having been squeezed to pay likely 250, maybe 300 dollars a share by the time they're finished being squeezed by the investors being long the stock, and punishing them for their ill-timed bet that cancer could not be cured.

So yeah, the position they are in is…uncomfortable. Like the magician's assistant in the box when the magician forgets about her and goes on lunch break.