A short position is a sale on a borrowed security. The investor needs to eventually return the borrowed stock by purchasing it back from the open market. If the price falls, the investor buys it back for less than he or she sold it for and pockets the profit.
A short squeeze occurs when investors with heavy short positions are forced to cover, or buy back, their shorts in the event of a sudden share appreciation – short sellers are essentially being squeezed out of their short positions, typically at a loss. Consequently, the additional buying momentum from short sellers covering their options contracts help bolster share prices even further.
Investors can identify securities at risk of a short squeeze by monitoring short interest – the total number of shares sold short as a percentage of total shares outstanding, along with the short-interest ratio – the total number of shares sold short divided by average daily volume.
Moreover, while investors wait for a short-squeeze to materialize, SQZZ can lend out securities from the fund’s underlying portfolio to short sellers and other market participants for a fee, which can generate income for investors in the form of dividends.
“While securities lending is commonplace, SQZZ will be partnering with major banks to optimize which securities to lend and to get the most income for the fund, which may bolster returns,” Lamensdorf added.
However, due to its frequent portfolio transactions, investors should be prepared for higher portfolio turnover and the potential tax consequences. The high turnover, which may involve commissions and other transaction fees, would also help explain the higher expense ratio for the fund.
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