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Oct 11, 2018

S3 Analytics: FAANG Shorts Outpace S&P October Decline

Tesla Inc (TSLA) and the FAANG stocks continue to be some of the largest shorts in the U.S. market, taking five of the top ten spots in the U.S. league table. While Tesla is a momentum, value and convertible arbitrage short, one of the main drivers for the large short interest in the FAANG stocks is their ability to be a “turbocharged” hedge for the long side of a portfolio

October’s performance reinforced the premise that the FAANG stocks are both a cheap and effective hedge for the long side of a portfolio by declining over twice as much as the S&P 500 even though the FAANG’s average beta is only 1.18. With FAANG stocks trading at general collateral levels, the cheapest stock borrow cost for the easiest to borrow securities, the FAANG hedge gave portfolio managers a significant bang for their short side hedging buck. FAANG shorts made $3.1 billion in October mark-to-market profits as a hedge to long side losses.

Reinforcing the idea that a large portion of FAANG shorts are being used as a portfolio hedge is the fact that there was continued shorting in size into the downward trending market. An additional 1.3 million shares, worth over $700 million, were shorted in October indicating that hedge funds were increasing their short hedges as declining stock prices ate into their overall short market value. That is not to say that there was no momentum shorting into the weak equity markets, but the overall size of the new short activity indicates there was more activity than momentum sellers could generate. In fact, short momentum trading was buoyed by this additional hedge related short selling, as FAANG short sellers garnered an outsized return relative to the rest of the market.

When the market begins its inevitable rebound, portfolio managers will begin trimming their FAANG short exposure as market values increase; this additional buy-side activity will accelerate stock price appreciation for the FAANG stocks. Adding in passive and index investment strategies which will be forced to buy back some or all of the shares they sold off in the market downturn, momentum traders will have yet another chance to earn outsized returns in the FAANG stocks by buying FAANG shares and this time riding the wave upward.

Want deeper insight into the above analysis?
Contact:  Ihor.Dusaniwsky@S3Partners.net
                 Managing Director Predictive Analytics, S3 Partners, LLC
The information herein (some of which has been obtained from third party sources without verification) is believed by S3 Partners, LLC ('S3 Partners') to be reliable and accurate. Neither S3 Partners nor any of its affiliates makes any representation as to the accuracy or completeness of the information herein or accepts liability arising from its use. Prior to making any decisions based on the information herein, you should determine, without reliance upon S3 Partners, the economic risks and merits, as well as the legal, tax, accounting and investment consequences, of such decision.

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