Lesson 12 of 25 · 6 min
An automaker's shares, 2008: a short squeeze read as a margin event
Price stopped clearing because the stock available to buy was smaller than the stock that had to be bought.
In October 2008 the ordinary shares of Volkswagen, the German carmaker, rose from a level reported at around two hundred euros to an intraday high reported above one thousand euros, briefly making it the most valuable listed company in the world. Nothing about the business changed in those days. The float did.
The arithmetic was disclosed on 26 October 2008. Another carmaker held, directly and through cash-settled options, economic exposure to roughly three quarters of the ordinary shares. A regional government held about a fifth. Index-tracking funds held much of the rest. The freely tradable remainder was reported at only a few percent, against short interest reported at around twelve percent of the shares.
When the shares that must be bought exceed the shares that can be bought, there is no clearing price in the ordinary sense. And a short position is not merely losing: as the price rises, the collateral required against it rises with the same move that creates the loss. Curing it requires buying, which raises the price, which raises the requirement again.
A second buyer was mechanical. The share's weight in the country's main equity index rose with its price, so index-tracking portfolios had to buy more of it at the top, a demand entirely insensitive to value. Weights were later capped by reference to free float. The price fell back toward five hundred euros within days.
Key terms
- Free float
- The shares actually available to trade, after excluding strategic and locked-up holders. It, not the share count, sets how much buying a price can absorb.
- Short squeeze
- A rising price forcing short sellers to buy, whose buying raises the price further. The loop is arithmetic, not sentiment.
- Cash-settled option
- An option paying the price difference in cash rather than delivering shares. The economic exposure sits with the holder while the shares sit with whoever hedges it.
Worked example
What a rising price does to a short's collateral
Illustrative figures scaled down so the arithmetic is followable; they are not the reported amounts. A short of 12,000 shares at 204 per share, with cash posted equal to 50 percent of the proceeds.
- Proceeds of the short sale
- 2,448,000
- Cash posted as margin
- 1,224,000
- Cost to close at 517
- 6,204,000
- Loss on the position
- 3,756,000
- Account equity
- −2,532,000
- Margin the position now requires
- 3,102,000
12,000 × 204.
50 percent of proceeds.
12,000 × 517.
12,000 × (517 − 204), or 3.07x the cash posted.
1,224,000 + 2,448,000 − 6,204,000.
12,000 × 517 × 0.50.
A 153 percent price rise produced a loss of three times the posted cash and a requirement of two and a half times it. Both numbers move in the same direction as the cure.
Check yourself
You are short 5,000 shares at 190 with cash posted equal to 50 percent of proceeds. The price reaches 640. What is the loss, and how has the margin requirement changed?
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Educational only. Nothing in this lesson is investment, legal or tax advice, or a recommendation to enter into any transaction. Figures are illustrative and computed from the inputs stated in the lesson.