Short Meets Long: When Securities Lending Data Illuminates Market Sentiment

September 26, 2017

Signs of changing market sentiment in the traditional cash markets are easily accessible. Investors enjoy the ability to see security share prices updated in near real time. Changes in analyst recommendations, filings to regulatory agencies, advanced price and volume charting over years’ worth of data and breaking news across tens of thousands of securities globally are available on many financial websites, free of charge. Much of this data is typically viewed from a long perspective as investors review price action and market fundamentals to determine if they should invest in a specific security at prevailing prices for a given time horizon.

While the securities finance industry has become considerably more transparent than it was a decade ago with the advent of specialized data providers such as DataLend, the critical metrics that market participants monitor on a daily basis are still relatively unknown outside the institutional marketplace. These metrics offer different information and highlight market sentiment from the short side—offering critical context for long investors such as asset managers, pension funds and other beneficial owners.

One example of securities finance market data reflecting market sentiment in the cash markets was exhibited in the recent U.S. initial public offering of Blue Apron (ticker APRN). Blue Apron is part of a growing market that develops and delivers packaged, high-quality food ingredients and recipes for home meal preparation. Unfortunately, the Blue Apron IPO suffered from awkward timing as Amazon (AMZN) had just announced the acquisition of Whole Foods Market (WFM) for $13.7 billion and separately began testing meal kits of its own.

APRN thus became a victim of the so-called “Amazon effect” as investors immediately saw the threat that Amazon posed to Blue Apron’s business. APRN closed at just a penny above its $10 IPO price on its first day of trading and went downhill from there. Indeed, Amazon’s announcement to acquire Whole Foods sent a shudder of fear throughout the entire supermarket industry, causing share prices of some stocks in the sector to drop by more than 20% in the days after the news broke.

Metrics reflecting the bearish market sentiment of APRN’s prospects were immediately evident days after the IPO settled. Fees to borrow shares of the company hit over 5,000 bps on its first day of trading in the securities finance market and reached a high of over 8,000 bps in August (see Figure 1). Utilization also shot up to just under 100% more recently, suggesting that virtually every share that could possibly be borrowed has been and is now on loan. Re-rating activity has also been very busy in this name and reflects increased demand to borrow shares. Immediately after the APRN IPO, shares were re-rated hotter in 10 out of 15 trading days, sometimes by several hundred basis points. Only four days out of the 15 saw re-rate activity result in slightly cooler volume-weighted average fees.

Short interest as a percentage of float in the 28% to 30% range also reflects bearish market sentiment in APRN (Figure 2). With rising fees to borrow, extremely high utilization percentages, hotter re-rates and a high short interest ratio, the securities finance market suggests that long investors in Blue Apron may want to anticipate further downside from its share price of less than $6 as of late summer 2017 as shorts keep the pressure on. In the meantime, however, long holders of Blue Apron may realize revenues from lending those positions while the share price stabilizes.

Broadening the data set

In addition to reflecting market sentiment at a security level, utilization, days to cover, short interest and fee metrics can be extrapolated and applied to an industry, sector, asset class, country and even regional level.

A recent example of applying aggregated securities lending data to observe broader market trends is exhibited in rising fees to borrow securities in the U.S. retail industry. Whether a result of the supposed Amazon effect or not, the share prices, fees, short interest and utilization figures of retailers such as Sears Holdings, Hudson’s Bay, J.C. Penny, Land’s End, Dillard’s Inc., Bon Ton Stores, Fred’s Inc., Restoration Hardware, Bebe Stores and many others reflect rising short activity in the retail industry during the first half of 2017 (Figure 3).

The volume-weighted average fee to borrow the U.S. retail industry increased from 80 bps to over 180 bps as of mid-summer 2017. That reflects a bearish market sentiment as short sellers are willing to pay more to borrow shares in traditional U.S. retailers as online vendors such as Amazon gain market share. Short sellers are sticking with their positions and in some cases increasing their short exposures, even as the cost to borrow some retail equities continues to rise.

When securities lending data turns bullish

That is not to say that all securities finance metrics are indicators of just bearish market sentiment. One data point used to gauge the possibility of a short squeeze (a scenario when a heavily shorted security suddenly moves higher as a result of buying activity) is the days-to-cover ratio. The days-to-cover metric is calculated as the number of shares on loan divided by the average daily trading volume of shares in the cash markets over the last 30 days. The ratio attempts to measure how many days would it take to close all the open short positions in a security; the higher the ratio, the longer it could take for shorts to cover their positions, and the longer a price rally could continue. A security trading with a high days-to-cover ratio in conjunction with a high short interest could be a candidate for a short squeeze, given the right catalyst.

One such example of a short squeeze happened in recent months with Cara Therapeutics (CARA), a pharmaceutical company. Cara Therapeutics was trading increasingly hot through spring 2017, with utilization climbing to 96% and fees to borrow in a very wide range between 800 and 9300 basis points. During this timeframe, days to cover rose from 3.2 to peak at 6.75 on June 15. Shortly thereafter, a short squeeze was triggered, ostensibly due to optimism regarding pending results on a Phase 2b trial of a pain medication in development. The stock rocketed up by 57% from $17.12 to reach a high of $26.95 on June 28 as shorts scrambled to cover their shares in the face of sudden buying pressure (Figure 4).

Ironically, the results of Cara Therapeutics’ Phase 2b trial were mixed. These results caused analysts to downgrade the stock, leading to an immediate sell-off that erased all share price gains triggered by the short squeeze. Fees and utilization for CARA have climbed back up to very high levels more recently.

Sell high, buy low

Just as rising fees, utilization and short interest can reflect increased shorting activity and bearish market sentiment, these same metrics decreasing can signal the covering of shorts. One such example occurred in Exact Sciences (EXAS), a biotechnology company specializing in cancer detection screening. In August 2016, fees to borrow EXAS were in the warm territory at around 150 bps, while utilization trended around 82%. The share price of Exact Sciences lumbered along in the $13 to $20 range until late February 2017. DataLend data saw more returns coming in than new loans, causing utilization to drop from a high of 90% to 69% by April. Fees to borrow the security dipped below 50 bps, while the days-to-cover ratio rose to 11. A short squeeze was triggered by better-than-expected earnings reported on April 26, causing the share price to rally from $23.80 to $30.14 in a single day.

Utilization and fees in EXAS continued to drop as the share price strengthened. Fees to borrow shares of the company fell to around 22 bps by late summer; short interest and utilization have also dropped down to 9.5% and 40%, respectively, in the same timeframe. Shares of EXAS traded in the $37 range in August, a 184% increase from the stock’s lows in early January. This example illustrates that securities lending data can be used from the long side as well: By combining technical analysis in the cash markets with securities lending metrics, observant investors may infer when the short sellers are covering their positions, allowing them to set up a trade from a long perspective.

It’s all in the details

Securities finance metrics are just as valuable to gauge market sentiment as the more traditional figures most financial services professionals are familiar with. Combining utilization and fee figures with days to cover, short interest, on-loan volumes, re-rating activity and other metrics can make for a compelling and more complete view of what is happening with a security, industry or asset class in both the securities lending and cash markets.