Do surprising fluctuations in short interest ratios of stocks indicate new information from short sellers that predicts returns of these stocks? In their November 2020 paper entitled “Surprise in Short Interest”, Matthias Hanauer, Pavel Lesnevski and Esad Smajlbegovic examine standardized unexpected short interest ratio as a stock return predictor. They define this variable as current short interest ratio minus 12-month simple moving average of monthly short interest ratios divided by standard deviation of short interest ratios over the past 12 months, calculated monthly for each stock. Using stock short interest data, associated stock returns and firm accounting data for U.S. publicly listed common stocks, excluding those priced less than $5 or in the bottom 5% of NYSE market capitalizations, as available during March 1980 through December 2013, they find that:
- For a subsample since 1995 with recorded short interest announcement dates, stocks in top (bottom) 30% of surprises in short interest ratios generate an average -0.25% (+0.27%) return over the next 30 days.
- Over the full sample period, an equal-weighted hedge portfolio that is each month long (short) the 10% of stocks with the lowest (highest) short interest ratio surprises generates 0.43% average gross monthly return. For a value-weighted hedge portfolio, average gross monthly return is 0.35% (see the chart below).
- Hedge portfolio alphas across an array of factor models of stock returns are similar in magnitude to raw returns, indicating that standardized unexpected short interest ratio represents a distinct source of information about future stock returns.
- Hedge portfolio gross profitability is particularly strong around earnings announcements, suggesting that short sellers trade on mispricing due to incorrect beliefs of others about company fundamentals.
- Return predictability is stronger among stocks that are illiquid, volatile and/or have widely dispersed analyst earnings forecasts, but is not related to stock shorting costs.
The following chart, taken from the paper, compares cumulative gross returns for equal-weighted and value-weighted hedge portfolios based on standardized unexpected short interest ratio as specified above during March 1980 through December 2013. Results indicate that the strategy is crash-resistant.
In summary, evidence indicates that unusual changes in stock short interest relative to the prior year relate negatively to future stock returns.
Cautions regarding findings include:
- Data are stale by seven years.
- Reported returns are gross, not net. Accounting for frictions from monthly portfolio reformation and shorting costs would reduce returns. Shorting may not always be feasible as required. Frictions are generally higher for equal-weighted than value-weighted portfolios.
- The methodology is beyond the reach of most investors, who would bear fees for delegating to a fund manager.
- There may be data snooping bias in the selection of a 12-month lookback interval for calculating surprises in short interest, but the paper states that different lookback intervals and other ways of calculating surprises produce qualitatively similar results.
For other research related to short interest, see results of this search.
Frequently Asked Questions
What is standardized unexpected short interest and what does it mean for stock investing?
Standardized unexpected short interest is a stock-level measure of how far the current short interest ratio deviates from its recent norm. It equals the current short interest ratio minus the 12-month simple moving average of monthly short interest ratios, divided by the standard deviation of those ratios over the past 12 months, calculated monthly for each stock. It is used to gauge whether short sellers are signaling new information about a stock.
Does a surprise increase in short interest predict lower stock returns?
Surprise increases in short interest do predict lower stock returns. Over March 1980 through December 2013, an equal-weighted hedge portfolio long the 10% of stocks with the lowest short interest surprises and short the 10% with the highest earned 0.43% average gross monthly return (0.35% value-weighted). Since 1995, stocks in the top 30% of surprises averaged -0.25% over the next 30 days, versus +0.27% for the bottom 30%.
How is a short interest surprise trading strategy built and tested?
The strategy each month ranks U.S. common stocks by standardized unexpected short interest ratio, going long the 10% with the lowest surprises and short the 10% with the highest. The test covers March 1980 through December 2013 and excludes stocks priced under $5 or in the bottom 5% of NYSE market capitalizations. Portfolios are formed equal-weighted and value-weighted, and alphas are checked against an array of factor models of stock returns.
Is short interest surprise just a repackaging of known return factors, or does it add distinct information?
Standardized unexpected short interest appears to be a distinct source of information about future stock returns rather than a repackaged known factor. Hedge portfolio alphas across an array of factor models are similar in magnitude to raw returns. Profitability is particularly strong around earnings announcements and in illiquid, volatile stocks or those with widely dispersed analyst earnings forecasts, but it is not related to shorting costs.
What are the limitations and risks of trading on short interest surprises?
The reported short interest surprise returns are gross, not net, so monthly portfolio reformation and shorting costs would reduce them, especially for equal-weighted portfolios. Shorting may not always be feasible, the data end in 2013 and are stale by seven years, and the methodology is beyond the reach of most investors, who would bear fund manager fees. The 12-month lookback may involve data snooping bias, though the paper reports qualitatively similar results with other lookback intervals and surprise calculations.