Friday, June 29, 2007

Harvesting the Shorts

The stock market seems to still be going up, but there is a game that might be going on right now. It revolves around unsophisticated investors shorting the market.

Every stock held in “Street Name” by your broker is available for shorting. In other words, the guy next to you in Star Bucks on his laptop could be borrowing your stock to short the market, Neat Huh?

Let's fleece the shorts. Here is what you are looking for, stocks that aren’t widely held by institutions. You want stocks that are being aggressively shorted that have a market cap of 20 to 90 million shares. Lots of bad press helps, even if you have to make it up.

Let’s pick KB Homes. The stock is trading at $39. There are 76 million shares outstanding. 17,646,073 shares are short right now with a turnover of 2.4 million short shares per day. Normal volume day is 3.5 million shares.

A group of “investors” get together and pool about 100 million in cash. On Monday, the group will establish their call options positions. Then they start buying shares; one million shares on day one and two million shares on day two. On day three, they go in like they are going to buy three million, but by that time, the shorts are running for the exits and buying to get out of their position.

The group will now sell into the shorts. If the group demanded delivery of the certificates for shares purchased, this could really put some hair on the dog. You can’t short a delivered certificate only stocks in "Street Name." This in turn, would dry up the number of shares available for shorting, which would drive the price further up. The group running the squeeze would cover the delivered certificates they are holding with $40 puts purchased when the stock pops through $70.(note,when you take delivery, it takes up to three weeks to get the certificate)

The only reason the squeeze is so successful, is because the average investor, has no concept on how the market can work against all logic. This is easy money. So when you see the market take off, the shorts are being burned.

The best time to start the “Harvest,” about one week before the expiration of the put and call options (third Friday of the month)—you get the most bang for the buck. The real clincher, this isn’t illegal in most foreign markets. It’s so simple even a hedge fund could do it!

Again, I could be shot for over simplification, there is a lot more that can actually play into this model and this isn’t a training manual!

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