Days to cover, or short ratio, is a common static when measuring the potential for short squeezes. The statistic simply measures a company’s current short interest, or shares currently shorted, over the average volume of a stock. As one might expect, days to cover is measured in days.
Why Days to Cover is Important
Days to cover is important because some traders believe it could show how long/violent a short squeeze could potentially be in relative terms.
For example, say stocks ABC and XYZ are both highly shorted due to negative sentiment.
- ABC has a short interest of 3 million shares, and its average daily volume is one million shares. From the above formula, ABC’s days to cover would be 3 days.
- XYZ has a short interest of 10 million shares, and its average daily volume is just 100,000 shares. XYZ’s days to cover would be 100 days.
If both ABC and XYZ have similar floats, and say something majorly positive of similar scale occurs to both (the two each crush earnings expectations), many traders believe XYZ’s short squeeze potential is higher than that of ABC and its short squeeze could be more violent.
In terms of visuals, imagine daily volume being a door to the exit, and short interest being the number of people in a room. If people in a room try to leave at once because something unexpectedly bad happens (the earnings report was really good and hurts the short thesis in our example), there could be more carnage in the room with more people.
Caveats to Days to Cover
While days to cover is important, investors should realize that it’s not the only statistic that matters in terms of short squeezes. Float size, future catalysts, investor sentiment, etc. can be just as important. If a stock’s float is very small, the price of that stock could move further/faster from the same amount of buying as a stock whose float is larger, all else equal.
A stock’s volume can also jump a lot quickly naturally, especially if there is a willing institution on the other side of the trade that hasn’t participated as much in the days before. If that is the case, the days to cover metric wouldn’t be as useful.
Disclosure: No Positions