Love them or loathe them, short sellers are here to stay. Theoretically, at least, they add stability and reduce volatility because they can be “buyers” when others dare not (reducing sudden dips down) and “sellers” when everyone else is stampeding to buy, which helps to cap sharp swings up. The academic research largely supports the proposition that short selling is a net positive for the market – and that’s why ASIC allows it in Australia.

Of course, short selling is selling something that you don’t own. A short seller profits from a falling price – selling at a higher price first, and then buying back at a lower price. It is the exact opposite of normal trading: buying first at a lower price to sell out at a higher price.

To short sell a stock, something that you do not own, you need to be able to “borrow” the  stock to make the delivery on the ASX. This is where the major fund managers and large superannuation funds come in – they lend the stock  to the short sellers. In return, the short seller secures the loan by giving the super fund cash. When the short seller closes the position on the ASX by buying the stock back, he/she returns the stock to the super fund and gets their cash back. The super fund gets paid for lending the stock by taking a margin on the cash.

Not all big super funds lend stock – but many do, so if you don’t like short selling, join a campaign to tell the super fund to stop. They will argue that they are boosting the returns for their members.

But let’s move on from the debate about whether short selling is good or bad and look at what we can learn from their actions. Firstly, it is useful to reflect on the “types” of short selling.

Broadly, there are four “types”. The first type is just a simple outright short sale – “company ABC is a dog of a company” – so the short seller sells ABC. Secondly, the relative short sale. This involves being “long” one company from an industry sector, and being “short” another company in the same sector. Essentially, the short seller is saying that company A will do better than company B. Examples could be buy Woolworths and sell Coles;  buy Fortescue and sell Rio; buy QBE and sell IAG; or buy CBA and sell ANZ etc. By being long one stock and short the other, the short seller is not taking market or industry risk, just relative performance risk.

The third type is a sector position, where companies from a particular industry or sector are sold because the short seller thinks that there are significant headwinds, or they are over-hyped and over-priced. A recent example related to discretionary retailers, which were targeted by short sellers when Amazon announced that it would be launching in Australia and many feared that local retailers would be wiped out. As it turned out, the short sellers got this spectacularly wrong. More recent examples have been banks, lithium miners and  rare earths producers.

The final type, which some argue is “good” short selling, relates to market makers and other professionals hedging derivative positions such as exchange traded options and warrants, or catering for settlement mismatches. Occasionally, a short seller may arbitrage the futures markets, resulting in widespread short sales of physical stocks.

Short sellers are required to report details of positions opened to ASIC, who then collate the data and publish a daily report. The sellers aren’t required to report the reason for taking the position out, so in reviewing the data, what we look for are unusual positions and how they are changing. This is further complicated by the reality that most stocks have some level of open short positions, so again, we need to be careful in rushing to judgement.

Listed below is the table of the twenty most shorted stocks as of 9 October. We compiled this list from the ASIC data, and published it in last Saturday’s Switzer Report.

Webjet is the most shorted stock based on the percentage of its share sold short. As of Friday, 15.19% of its ordinary shares, or 51.5m shares out of a total base of 339m shares, had been sold short.

Myer, which has 821.3m ordinary shares on issue, had 85.1m shares short sold. This gave it a ranking as the third highest shorted stock at 10.37%.

In contrast, CSL came in 347^th place, with 1.3m shares short sold out of a base of 455m ordinary shares (0.27%).

20 most shorted stocks – as at 9 October 2020

The table also shows the change over the week. A “green” or positive change means that net short positions were closed, a “red” or “negative” change means that net short positions were opened. So last week, short sellers opened positions in Mesoblast (MSB) – it recorded  an increase of 2.69% as short positions went from 5.96% to 8.61%, while short positions were closed by 1.21% in Webjet.

What can we learn from the short sellers?

Here are some current observations:

• Myer (MYR), Invocare (IVC), Inghams (ING) and Freedom Foods (FNP) are in the short sellers’ sights. These aren’t new positions, and the short sellers don’t seem in any particular hurry to close;
• Some short sellers don’t see a rapid recovery in the travel sector, or alternatively, feel that the market has already priced some of this in. Significant short positions have been taken in Webjet (15.19%), Flight Centre (6.27%) and Corporate Travel Management (CTD, 5.39% and 30^th position);
• Lithium/graphite producers such as Galaxy Resources, Orocobre, Pilbara Mining and Syrah Resources (SYR, 5.29% and 32^nd position) remain under fire;
• Mesoblast (MSB) punters should be wary of the short selling interest in the stock. Significant new positions have been opened;
• There are not material short positions in the major banks. ANZ at 0.96% is ranked 214^th, CBA at 0.75% is ranked 250^th, NAB at 1.40% is ranked 162^nd and Westpac at 0.92% is ranked 225^th. However, the positions in regional banks BOQ at 8.10% (eighth) and Bendigo (BEN) at 5.05% (35^th) are significant. While I don’t think you can conclude that short sellers are long the major banks and short the regional banks, there is a definite wariness about the regional banks.
• The short sellers don’t always get it right. But they are investment professionals, so you would expect them to get it right more often than they get it wrong. Knowing how they are positioned can be an important data input into investment decisions.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regard to your circumstances.