Adjusted short interest

What Is Adjusted Short Interest?

Adjusted short interest refers to the total number of shares of a particular security that have been sold short by investors but have not yet been covered or closed out, with additional consideration for factors that can influence the interpretation of this figure. While raw short interest provides a numerical count, "adjusted" implies a refinement or contextualization of this data, often for more precise market sentiment analysis. This metric is a key component within investment analysis, offering insights into bearish sentiment among market participants. Unlike a simple tally, adjusted short interest seeks to present a more nuanced view by accounting for elements like the number of shares available for trading or the typical trading volume of a security.

History and Origin

The practice of short selling, upon which short interest data is based, has a long and often contentious history, dating back to the 17th century with figures like Isaac Le Maire shorting the Dutch East India Company.⁸ Over centuries, the concept evolved as markets grew more sophisticated. Initially, short interest was simply the number of borrowed shares that had been sold but not yet repurchased. However, as financial markets matured and regulatory frameworks developed, the need for more granular and contextualized data emerged.

Regulatory bodies began requiring the reporting of short positions to increase transparency. In the United States, for instance, the Financial Industry Regulatory Authority (FINRA) requires broker-dealer firms to report short interest positions in all equity securities twice a month.⁷ The emphasis on "adjusted" short interest grew as analysts recognized that a raw number alone could be misleading without considering a company's total shares outstanding or its daily trading activity. This evolution reflects a broader trend in financial analysis towards more comprehensive and interpretable data, moving beyond simple counts to ratios and contextualized metrics that provide deeper insights into underlying market dynamics.

Key Takeaways

• Adjusted short interest provides a more contextualized view of short selling activity than raw short interest.
• It often considers factors like a company's shares outstanding, free float, or average daily trading volume to gauge the intensity of bearish sentiment.
• A high adjusted short interest can signal strong negative sentiment or potential for a short squeeze.
• Regulatory bodies like FINRA and the SEC play a role in standardizing the reporting of short positions, which forms the basis for adjusted short interest calculations.
• The metric is utilized by investors and analysts to assess market sentiment, inform trading strategies, and evaluate a security's risk profile.

Formula and Calculation

While there isn't a single, universally accepted "adjusted short interest" formula, the concept typically involves normalizing the raw short interest figure against another relevant metric to provide a more meaningful ratio or percentage. The most common form of adjusted short interest is the short interest ratio (also known as "days to cover"), which relates the total shares sold short to the average daily trading volume.

The formula for the short interest ratio is:

Where:

• Total Shares Sold Short is the aggregate number of shares that investors have sold short and not yet repurchased.
• Average Daily Trading Volume is the average number of shares traded per day over a specified period (e.g., 30 or 60 days).

Another way short interest might be "adjusted" is by expressing it as a percentage of a company's publicly available shares, often referred to as the "float."

Where:

• Public Float refers to the number of shares available for public trading, excluding restricted shares or those held by insiders.

These adjustments provide context for the raw short interest number, helping investors understand the magnitude of short positions relative to a stock's liquidity or tradability.

Interpreting the Adjusted Short Interest

Interpreting adjusted short interest depends heavily on the specific adjustment used. For example, a high short interest ratio (days to cover) indicates that it would take many days of average trading volume for all outstanding short positions to be covered. A high ratio often suggests significant bearish sentiment and, potentially, an elevated risk of a short squeeze. Conversely, a low ratio might suggest either limited bearish interest or an easy ability for short sellers to cover their positions without significantly impacting the stock price.

When considering short interest as a percentage of the float, a high percentage suggests that a large proportion of readily tradable shares are held in short positions. This indicates strong conviction among short sellers that the stock's price will decline. However, it also means that if positive news emerges, the scramble by numerous short sellers to buy back shares could lead to a rapid price increase due to a lack of available shares. Both metrics of adjusted short interest offer a deeper understanding of the market's collective view and potential future price movements than the raw short interest number alone.

Hypothetical Example

Consider Company XYZ, which has 100 million shares outstanding and a public float of 80 million shares. Its current raw short interest is 8 million shares. Over the past 30 days, Company XYZ's average daily trading volume has been 2 million shares.

1. Calculate Short Interest Ratio (Days to Cover):

   $$\text{Short Interest Ratio} = \frac{8,000,000 \text{ shares (Total Shares Sold Short)}}{2,000,000 \text{ shares (Average Daily Trading Volume)}} = 4 \text{ days}$$

   This means it would theoretically take 4 days of average trading volume for all short sellers to cover their positions.

2. Calculate Short Interest as Percentage of Float:

   $$\text{Short Interest as Percentage of Float} = \frac{8,000,000 \text{ shares (Total Shares Sold Short)}}{80,000,000 \text{ shares (Public Float)}} \times 100\% = 10\%$$

   This indicates that 10% of Company XYZ's publicly tradable shares are currently held in short positions.

An investor might interpret a 4-day short interest ratio and a 10% short interest as a moderate level of bearish sentiment, but also a potential for significant price volatility if a catalyst triggers short covering. This detailed view, which takes into account a company's public float, provides more context than just knowing that 8 million shares are short.

Practical Applications

Adjusted short interest serves several practical applications in financial markets and analysis:

• Sentiment Indicator: It acts as a direct measure of bearish market sentiment against a specific stock. A higher adjusted short interest suggests that a significant number of investors anticipate a price decline.
• Short Squeeze Identification: Stocks with a high short interest ratio are often considered candidates for a "short squeeze." If positive news causes the stock price to rise, short sellers may be forced to buy back shares to limit losses, driving the price up further. This phenomenon can lead to rapid and dramatic price increases.
• Risk Assessment: For investors holding long positions, a high adjusted short interest can indicate a higher potential for volatility. While it suggests many are betting against the stock, it also presents the risk of a sharp upward movement if short sellers are forced to cover.
• Fundamental Analysis Complement: While not a fundamental metric itself, adjusted short interest can complement fundamental analysis by showing how informed investors (short sellers are often considered "informed traders") are positioning themselves relative to a company's financials. Academic research has shown that aggregate short interest can be a predictor of future equity returns.⁶
• Arbitrage and Hedging Strategies: Sophisticated traders might use adjusted short interest to identify potential arbitrage opportunities or to fine-tune their hedging strategies, especially when dealing with options or other derivatives.

Regulatory bodies also use short interest data to monitor market integrity. The U.S. Securities and Exchange Commission (SEC), through rules like Regulation SHO, aims to prevent abusive short selling practices such as "naked" short selling, where shares are sold short without being borrowed.⁵ Data on short interest and related metrics like "fail-to-deliver" positions are crucial for enforcing such regulations and ensuring orderly markets.

Limitations and Criticisms

While adjusted short interest offers valuable insights, it comes with limitations and criticisms. One primary concern is that short interest data is reported with a delay, typically twice a month by FINRA and then published by exchanges like NYSE and NASDAQ.⁴ This means the data reflects positions from several days prior to publication, potentially making it stale in rapidly moving markets. The information may not capture the most current short selling activity, which can change significantly in a short period.

Another criticism is that a high adjusted short interest can be interpreted in conflicting ways. While some see it as a bearish signal, others view it as a contrarian indicator, suggesting that all the negative sentiment is already "priced in" and that the stock is ripe for a rebound or a short squeeze. This dual interpretation can make it challenging to use definitively as a standalone signal.

Furthermore, adjusted short interest doesn't differentiate between various motivations for short selling. Some short positions might be taken for directional speculation, betting on a price decline, while others might be part of a hedging strategy, such as converting convertible bonds or engaging in other complex arbitrage plays. These different motivations can distort the true "bearish sentiment" implied by the aggregate number. Moreover, issues like "fail-to-deliver" can complicate the accuracy of reported short interest, although regulations like SEC Rule 204 of Regulation SHO aim to mitigate such issues by requiring broker-dealers to close out these positions.³

Adjusted Short Interest vs. Short Interest

The terms "adjusted short interest" and "short interest" are closely related, with the former being a refinement or contextualization of the latter.

In essence, short interest is the raw data point, while adjusted short interest represents various analytical transformations applied to that raw data to make it more informative for price discovery and strategy development. An investor would typically use adjusted short interest metrics, such as the short interest ratio or short interest as a percentage of float, rather than just the raw short interest number for more meaningful analysis.

FAQs

What is a high adjusted short interest?

A high adjusted short interest varies by industry and stock, but generally, a short interest ratio (days to cover) above 5-10 days is considered high. Similarly, a short interest as a percentage of float above 10-20% is often viewed as significant. These levels indicate strong bearish sentiment or a potential for volatility due to a large number of outstanding short selling positions.

How often is adjusted short interest updated?

Adjusted short interest figures are derived from raw short interest data, which is typically collected and reported by FINRA from broker-dealer firms twice a month. This data is then usually published by major exchanges like NYSE and NASDAQ with a slight delay, often a few days after the reporting settlement date.²

Can adjusted short interest predict stock price movements?

Adjusted short interest can be an indicator of future stock price movements, particularly in identifying potential short squeezes when combined with other factors like positive news or catalysts. Academic research suggests that short sellers are often informed traders whose collective positions can predict future returns.¹ However, it is not a guaranteed predictor, and market outcomes are influenced by many variables.

What is the difference between short interest and naked short selling?

Short interest is the total number of shares that have been legitimately sold short and not yet covered. Naked short selling, on the other hand, refers to the illegal practice of selling shares short without first borrowing them or ensuring they can be borrowed, leading to "fail-to-deliver" positions. Adjusted short interest specifically refers to analyzing reported short interest data, which should not include illegal naked short positions if regulations are properly enforced.