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Short interest drops in November




Short interest for the period between mid-October and mid-November showed a second consecutive month of declines in NASDAQ short interest as well as a decline in NYSE short interest.

As you may recall, I am of the opinion there is a short bubble in the market. So many people are leaning on stocks for so many reasons that the potential for a breakaway upside move fueled by short covering is real. I will note, however, that just as the "bubble" on the bull side went longer than many contrarians expected, this bubble may continue to expand beyond what the bulls think reasonable.

In my last News & Views on this subject, I noted some Buzz conversation that the general rise in short interest indicated by the graph above was not a true measure of bearishness but a function of derivative hedging: "short interest may be due to the growth in derivatives." Or, as Prof. Succo put it, "short equity offset by long equity exposure in derivatives."

I don't disagree with Prof. Succo here, I just believe that these hedges have a cost. Not only are hedgers paying fees, interest, and in-kind dividends, they have a cost related to the rise of the underlying securities. At some point, that cost will outweigh the benefit of keeping the hedge in place. Holders of these positions cannot become too complacent. If they are as hungry for bits and pieces of performance as the collective intelligence of the Minyanville Professors believe they are, then they will examine these costs closely.

It could be the reaction to such an examination is to leave the short positions intact and do their rebalancing on the derivative side. The function of this would be to leave the short bubble intact.

My gut tells me, though, current levels of short interest are unsustainable. To borrow a phrase from Boo's side of the ledger, I can't tell you when it will matter. Only that I believe it will matter.

Back in my home sector, of the 23 companies in our coverage universe, 18 saw their short interest decline. Short interest in the IBB, the iShare ETF for the NASDAQ Biotech Index, dropped 14.32%. The BBH, a HOLDr ETF approximating the AMEX Biotech Index, saw short interest rise 1.95%.

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No positions in stocks mentioned.

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