I am an occasional trader but really somewhat of a novice in the finer points of investing. I am long and holding and have read on this board for months on end of the possibility of a squeeze whereby shares are not available for purchase, shorts need to cover and prices go up.
I guess my question is why do the shorts "need" to cover---if for whatever reason(good ER's. new customers etc.) the stock goes higher rather quickly why can't the shorts just pay the additional carrying fees and hold for a longer period of time when they believe the stock prices may come back down.
Short squeezes occur because of margin calls made by an investor’s broker as the price of a stock sold short increases. The investor who tells his broker to buy him in (because he doesn’t want to deposit more money to his account to satisfy the margin call or because he is fearful that the stock he sold short will continue to rise and additional margin calls will follow) adds upward pricing pressure on the stock by buying back the shares he sold short. The larger the short position outstanding and the higher the short ratio, adds additional buying pressure on the stock sold short as other short sellers try to avoid further exposure and buy back the shares they borrowed in order to repay their stock loans from their brokers. The buying increases as an increasing number of short sellers try to get out the door before the others.
Here's a simplified explanation of how squeezes typically occur:
A short sale is a margin transaction whereby the 'investor' borrows the stock he sells rather than borrow part of the purchase price of a stock. The proceeds of a short sale are held by the broker as collateral (equal to 100% of the value of the shares borrowed at the time of the sale.) However, as in any margin transaction, the investor must post at least 50% initial margin (as required by the Federal Reserve Board's Regulation T) and maintain an equity in the position equal to at least 20% (minimum NYSE maintenance requirement.)
When the value of a stock sold short increases, additional collateral is required by the broker to support the stock loan. When the investor's equity drops below the 20% margin maintenance requirement (some firms have a 25% requirement) a margin call for additional funds (collateral) will issue.
Margin calls are the primary reason that short sellers will instruct their brokers to buy-in shares to cover (close out) their short sales rather than deposit additional funds with their brokers. As the price of the stock sold short increase, more margin calls are issued and short positions bought-in in the open market, creating upward pricing pressure.
In addition, brokers charge interest to maintain short positions should they increase in value above the price at which they were sold short. And, depending on the particular situation, the broker may charge a premium for 'hard to borrow' stocks that are loaned to their customers.
As noted above, I've given a simplified explanation in response to your question. If you are contemplating selling stock short, I suggest you speak with people knowledgeable in this field, which is very complex and complicated.
Data-Source----Thanks for your time and additional details. I will likely never be a short seller since, in theory, the amount you could lose is infinite.
However a sudden rise in the price could cost the shorts a whole bunch of money to cover. IF they feel the stock is overpriced it would be cheaper to pay the interest and additional margin amounts and wait til it drops in price(if ever).
That was my only point.
I am not short and have held RBCN for a LONG time. Unfortunately I own it at 29$+ and would love to see it go to 40$. I am simply saying that because a company has a large percentage of short sellers does not automatically generate a short squeeze. Some external event(s) has to occur that permanently drives the price up otherwise the shorts can simple pay more in fees and extend the coverage time if they believe the stock price will eventually come back down. The additional carrying costs would likely be a lot cheaper then covering at a high price.
Where is the mistake in my reasoning?
None at all - you've explained the typical short squeeze paradigm quite well. A major event (usually M&A, but also something external such as a major competitor retreating from the market, and the company in question increasing market share as a result) needs to occur in order for the price to be ~permanently~ increased, and thus the flaw in much of the short-squeeze reasoning on these and other boards.
We've been through multiple quarters now where short interest has been quite high, RBCN ER has been stellar, outlook has been notably optimistic, and yet haven't seen the "short squeeze" scenario play out yet. This is because the street is still skeptical about the long-term prospects of RBCN's demand model, and therefore will continue to value the stock at around the 28 - 35 range for the foreseeable future. While this will make shorts nervous - and likely continue to drive the price up over the next 6 months - it's not going to create the instant pop that folks are looking for.
In other words, a short squeeze is an arbitrage event within a stock that has significant short interest. RBCN is fairly valued at the present; difficult to imagine what could be announced on May 5 that will create an arbitrage opportunity for buyers.
If the stock rises higher, shorts will become upside down in their position. Their brokers will begin placing margin calls. Shorts COULD just dump in money, but if some shorts dump in money, but the rest decide to liquidate their position and buy the stock, they'll force the price even higher. Which means you now face ANOTHER margin call. Some add cash. But some buy, forcing the stock higher. You face ANOTHER margin call...Yeah, you could do that, I guess....