These heavily shorted stocks could see short-term rallies to start 2020, reports Rocky White.
Investors holding very profitable positions will astutely wait until after Jan. 1 to sell. This postpones paying taxes on the profits by a year. Short sellers, on the other hand, who have made money will wait until after the New Year to cover their short position. In the analysis below, I’ll first look for evidence that we can identify early year short covering rallies. After that, I show a list of stocks that might benefit from this phenomenon.
SHORT-COVERING RALLIES THE LAST TWO YEARS
First, I want to find out if the short-covering rallies are detectable in the data. What we’re looking for are stocks that are heavily shorted in which the short sellers have a significant profit.
For the study below, I considered stocks with at least 10,000 options in total open interest. I looked back at 2018 and separated out the stocks that were heavily shorted (defined as stocks with at least 10% of float sold short). Then I grouped the stocks by those that were down 10% or more, those down less than 10%, and those that were positive. Based on the theory described above, those stocks that are heavily shorted and down significantly for the year (so short sellers have a healthy profit) should rally early the next year as those shorts get covered.
Looking at the table below, there’s a strong case that these short-covering rallies are identifiable. The bolded column shows highly shorted names that were down a lot in 2018. These were the best stocks going by average return and percent positive. Also, an impressive 88% of these stocks beat the SPDR S&P 500 ETF Trust (SPY), which is better than any of the other stock groupings. So, these are the stocks that were most likely to beat the benchmark.
Another important data point is the average positive. If our theory is correct, then the stocks getting covered should see some extra upward pressure compared to other stocks. Again, the stocks in that first column lead the way by average positive. This is an especially important stat for options players who benefit from violent short-term rallies.
Below is similar data using the same methodology but going back to the year before. I looked at stock performance and short interest through 2017, and then found the returns of those stocks in the first week of 2018. This time, those beaten down, heavily shorted stocks still beat the benchmark at a greater rate than other stocks and they had the highest average positive. The outperformance between that bracket and the others wasn’t as big though. They did not have the highest percentage of positive returns either. However, there’s still enough here to convince me these are good setups for early 2020.
POTENTIAL SHORT-COVERING RALLIES IN 2020
Finally, we get to the most important part. Below is a list of 20 stocks that are down at least 10% in 2019 with at least 10% of their float sold short. These stocks meet the criteria looked at above for highly shorted, beaten down stocks that could benefit greatly from early-year short covering. Based on the analysis above, these stocks should have a higher probability than normal to spike big in the first week of 2019. It’s a good stalking list for short-term trades in the first week or so of next year. Additionally, it might be a confirmation indicator for those considering purchasing a technically weak stock.
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