Total ‘short’ stock bets fall, but bears stand firm on some

This article was originally on a blog post platform and may be missing photos, graphics or links. See About archive blog posts.

‘Short sellers’ pulled back further on their bearish stock bets in the first two weeks of August as the market continued to rally, new data show.

But those bets remained high in shares of some struggling financial companies -- including Freddie Mac and Washington Mutual Inc. -- indicating that the bears were confident that those stocks would head lower.

Short sellers borrow stock (usually from a brokerage) and sell it, hoping the market price will fall. If the bet is correct, the short seller can eventually replace the borrowed shares with stock bought at a lower price and pocket the difference between that price and the original sale price.

Short selling mushroomed from October to mid-July as the stock market mostly fell in that period. But Wall Street’s rally since mid-July has given some shorts second thoughts. After all, they lose if share prices rise instead of fall.

The total of shorted shares on the New York Stock Exchange fell to 17.8 billion as of Aug. 15 from 18.3 billion on July 31, a 2.7% decline, the NYSE said today. Short sales hit a record high of 18.6 billion shares in mid-July.

The recent drop was greater on Nasdaq, where the number of shorted shares slid to 10.15 billion as of Aug. 15, down nearly 6% from 10.8 billion on July 31.

The two markets report the number of shorted shares every two weeks.

Bank and brokerage stocks had been favorite targets of many short sellers this year as the financial system’s woes worsened.

That led to the Securities and Exchange Commission‘s controversial decision to ban so-called naked shorting in 19 big financial issues from mid-July to Aug. 12. In a naked short sale, a trader puts in an order to sell a stock without having the borrowed shares lined up.

You can read more about the SEC’s decision here. Although the agency said it had no qualms about legitimate (i.e., non-naked) short selling, one question the SEC’s move raised was whether even legitimate short sellers would think twice about further shorting of battered financial issues, with the SEC clearly trying to halt the meltdown in those shares.

The shorts have in fact backed off from some financial stocks. But there hasn’t been a wholesale retreat. Here’s a look at the changes in short-sale totals of selected financial companies from July 31 to Aug. 15:

-- The number of shorted shares of Freddie Mac barely budged in the two weeks, easing from 119.4 million to 118.6 million. Ditto for Freddie’s sister, Fannie Mae, which saw its shorted total slip from 146.4 million shares to 141.4 million. Those who stayed bearish made the right call, as the stocks continued to plummet in the period (although they’re rallying this week).

-- Short sellers also didn’t pull back much in the case of Washington Mutual. Its shorted-share total was 338.6 million as of Aug. 15, little changed from 341.1 million shares two weeks earlier.

-- Two stocks that saw significant declines in the number of shorted shares: Merrill Lynch & Co., from 54.9 million to 42.3 million; and Lehman Bros. Holdings Inc., from 82.1 million to 70.6 million.

-- The shorts sharply boosted their bets on Santa Monica-based FirstFed Financial Corp. (from 8.7 million shares to 12.6 million in the two weeks) and did so modestly in the case of Newport Beach-based Downey Financial Corp. (from 14.7 million shares to 14.9 million).