Short interest is a popular metric on Wall Street because it gives a peek into the amount of negative sentiment a stock has. For their part, leveraged ETFs thrive on the directionality short interest can sometimes signal, and offer another tool for leveraged ETF traders to use.
For instance, taking a look at the stocks represented under Direxion Daily S&P Oil & Gas Exp. & Prod. Bull 3X Shares (NYSE: GUSH) and Bear 3X Shares (NYSE: DRIP) short interest in the extraction industry is, for the most part, on the rise.
According to Yahoo Finance, this holds for Carrizo Oil & Gas, Inc. (NASDAQ: CRZO), which is showing 22.63 percent against the float, Whiting Petroleum Corporation (NYSE: WLL), currently at 22.55 percent, as well as several others held by the ETF. If your own short-term thesis is in line with this trend, the bear ETF might be the optimal way of approaching that industry.
Conversely, lower short interest can serve as a similar indication on approaching a bullish position. However, little to no short interest doesn’t necessarily mean people don’t think the stock will drop. For one, large-cap stocks generally carry a lower percentage of short interest due to the large number of shares available. Another reason is simply that the risk of shorting certain stocks outweigh the benefit, especially compared to smaller, more volatile companies.
Nevertheless, it is possible to undertake a bullish position contrary to those shorting the stock, especially when short interest is high; for example, the Direxion Daily S&P Biotech Bull 3X Shares (NYSE: LABU) and Bear 3X Shares (NYSE: LABD) ETFs.
By their nature, biotech stocks generally carry a high percentage of short interest at any given time. As a result, when company or industry news signals potential growth, investors with a short position in these companies might get forced out of their position in a short squeeze. When this happens, buying action is amplified by both traders trying to enter a bullish position and traders trying to close a short position.
When this happens, leveraged ETFs like LABU can take advantage of the clear directionality of the underlying index’s gains.
As with all strategies that incorporate leveraged ETFs, these approaches work best in a short-term time frame.
This article was written in conjunction with Direxion.
Investing in a Direxion Shares ETF may be more volatile than investing in broadly diversified funds. The use of leverage by a Fund increases the risk to the Fund. The Direxion Shares ETFs are not suitable for all investors and should be utilized only by sophisticated investors who understand leverage risk, consequences of seeking daily leveraged, or daily inverse leveraged, investment results and intend to actively monitor and manage their investment. The Direxion Shares ETFs are not designed to track their respective underlying indices over a period of time longer than one day.
An investment in each Fund involves risk, including the possible loss of principal. Each Fund is non-diversified and includes risks associated with the Funds’ concentrating their investments in a particular industry, sector, or geography which can increase volatility. The use of derivatives such as futures contracts and swaps are subject to market risks that may cause their price to fluctuate over time. Each Fund does not attempt to, and should not be expected to, provide returns which are three times the performance of their underlying index for periods other than a single day. Risks of each Fund include Effects of Compounding and Market Volatility Risk, Leverage Risk, Counterparty Risk, Intra-Day Investment Risk, risks specific to investment in the securities of the Energy Sector and the Oil and Gas Industry, for the Direxion Daily S&P Oil & Gas Exp. & Prod. Bull 3X Shares, Daily Index Correlation/Tracking Risk, Valuation Time Risk and Other Investment Companies (including ETFs) Risk, and for the Direxion Daily S&P Oil & Gas Exp. & Prod. Bear 3X Shares, Daily Inverse Index Correlation/Tracking Risk and risks related to Shorting and Cash Transactions. Please see the summary and full prospectuses for a more complete description of these and other risks of each Fund.
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