What is short interest?

Short interest is the number of shares of a company’s stock that have been sold short and have not been bought back. In other words, the shares borrowed have not been bought back and returned to the lenders. Both the NYSE and the AMEX, as well as the Nasdaq, publish monthly figures of the short sales of listed companies. These are published in the financial newspapers at the end of each month. Short interest can be expressed as a percentage, which is the number of shares shorted divided by the company’s number of shares outstanding.

A large increase or decrease in a company’s short interest is used as an indicator of investors’ sentiment for that stock. For example, if Intel’s short interest increases by 15 percent in one month, you know that 15 percent more investors believe that Intel will decrease in price. However, these investors also could be wrong, which leads to the contrarian point of view: If there are so many who believe that the stock is going to decline, this puts a floor under the stock price at a certain point where these short sellers are going to have to buy the stock back to cover their short positions, resulting in an increase in the stock price.

Contrarian investors use the short-interest ratio for more information about the stock. The short-interest ratio (also known as the days-to-cover ratio) is the number of shares sold short divided by the stock’s average daily volume. For example, if Intel has a shortinterest ratio of 1.5, it would take 1.5 days for short sellers to cover their positions. The higher the ratio, the longer it takes to buy back shares to cover short positions. Short-interest ratio also can be used as a barometer for the market. The higher the short-interest ratio for the NYSE, for example, the more bearish is the sentiment for that exchange.

NYSE CIRCUIT BREAKER SYSTEM

In an attempt to reduce volatility and maintain investor confidence when the market goes up or down significantly, the NYSE instituted a circuit breaker system of trading curbs. This was as a consequence of the market crash of October 1987, which was blamed on program trades. Program trades are defined as a basket of 15 or more stocks from the Standard & Poor’s (S&P) 500 Index valued at $1 million or more that are bought or sold when they reach certain price limits and are triggered by computers. The NYSE resets the trading curbs on a quarterly basis based on the Dow Jones Industrial Average (DJIA). Following were the curbs for the third quarter of 2006:

160-point move on the DJIA.A160-point move up or down from the previous day’s close on the DJIA will trigger the circuit breaker. This affects arbitrage or program trades on the component stocks of the S&P 500 Index. In an up market, arbitrage buy orders can be executed only on a minus or zero-minus tick. Similarly, in a down market, sell orders can be executed only on an up-tick or zero-plus tick.
1,100-point move. If the DJIA goes down by 1,100 points or more from the previous day’s close, trading halts are instituted. The point levels for the trading halts are adjusted four times a year (January 1, April 1, July 1, and October 1). The point levels are set at 10, 20, and 30 percent of the Dow’s average closing values for the previous month rounded to the nearest 50 points. The current 1,100-point level is reflective at the time of this writing. The trading halts are one hour if the downside of 1,100 points or more occurs before 2 p.m. Eastern Daylight Time. If the downside occurs between 2 and 2.30 p.m., trading is halted for 30 minutes.
2,250-point move. If the DJIA goes down by 2,250 points or more (20 percent decline) before 1 p.m., this will cause a trading halt of 2 hours. Such a drop between 1 and 2 p.m. will trigger a trading halt of one hour. After 2 p.m. it will cause the NYSE to close for the day.
3,350-point move. A drop of 3,350 points or more (30 percent decline) from the previous day’s close of the Dow will close the NYSE for the day.

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