With the commoditization of such basic quant factors as value and momentum, in recent years systematic investors have turned more and more to sentiment based alpha signals. Aggregated open short interest level provides a profitable, low turnover signal rooted in buy-side sentiment, aka "the smart money." Dr. Stauth will cover the basics of short selling and data availability and will review the research and proprietary formulation of the StarMine short interest model as well as covering a range of sample trading strategies.

1. Finding Alpha in Short Interest Data
New York, March 21, 2013
Jessica Stauth, Ph.D.
Director, Quant Product Strategy – Thomson Reuters

2. Short Interest as Stock-ranking Signal
• Introduction
• StarMine Signal overview, In/Out of Sample and Live Returns
• StarMine SI Model Formulation
– Baseline ratio
– Institutional Ownership adjustment
– Merger arbitrage
– Dividend payments
– Short Squeeze Indicator
• Recap – universe selection, correlations and turnover
• Q&A
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3. Introduction
• What is a short sale? Why is a short sale?
• How can I find out how many shares are sold short
for a given stock?
• Can short interest data be used as an input signal
for quantitative investment strategies?
• What risks or known caveats are there to a strategy
of following the shorts?
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4. What/Why is a short sale
• What is a short sale? The sale of a security that the seller
does not own (or deliver).
• Why is a short sale?
– Fundamental Shorts – aka Valuation shorts: when an investor has
conviction that an individual stock is overvalued.
– Hedge shorts – risk management technique to reduce exposure
incurred through long investments. e.g. pairs trading
– Arbitrage shorts – exploit mispricing between two assets or asset
classes. e.g. M&A arb (buy the acquiree, short the acquirer) or convert
arb (buy the debt, short the equity)
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5. LINK
HLF – Ackman v Icahn, value short or prelude
to the „mother of all short squeezes‟ ?
Feb 6
Yesterday…
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6. How can I find out how many shares are sold
short for a given stock?
From the exchange e.g. NASDAQ , NYSE, AMEX
Data is available on a twice-monthly basis on an 8-day delay
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7. Can short interest data be used as a signal for
quantitative investment?
Yes. A simple ratio of shares sold short / shares outstanding (or shares
short/ADV) can be used as a buy-side sentiment signal.
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8. What risks or known caveats are there to a
strategy of following the shorts?
• Trying to short „hard to borrow stocks‟ , which, even when you
can short them, incur high t-costs
• Emulating short positions or changes in shorting levels that
are not reflective of “value” shorts, but rather are hedges or
arbitrage shorts.
• Data shortcomings
– the free/cheap exchange provided data is “low frequency”
and published at a delay (actually based on the nature of
the signal neither of these is a deal-breaker).
– must be sourced from each exchange independently –
can be a pain if you want to trade on many exchanges.
• Possibility of a „short squeeze‟ or loan recall
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9. Short Interest as Stock-ranking Signal
• Introduction – what is a short sale, and why should quants care
• StarMine Signal overview, Out of Sample and Live Returns
• StarMine SI Model Formulation
– Baseline ratio
– Institutional Ownership adjustment
– Merger arbitrage
– Dividend payments
– Short Squeeze Indicator
• Recap – universe selection, correlations and turnover
• Q&A
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10. StarMine Signal Overview
Shares
Shares Shares
Held by
Sold Short Outstanding
Institutions
Conditioning Factors:
Adjusted Baseline
1. Dividend Payments
Short Interest Rank
2. M&A Activity
StarMine Short Interest Final Rank
The StarMine Short Interest Model combines short interest data from US
exchanges with institutional holdings and accounts for dividends and M&A in an
intelligent, robust way.
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11. Comparable in and out of sample performance –
a good sign we didn‟t overfit.
The StarMine SI model was built on in-sample data from 1/2004 –
1/2009 and tested on out-of sample data from 1/2009 – 1/2011
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12. Long/Short returns continue to look good in the first 24
months of true out of sample (aka “live”) data
Live Results
Cumulative returns to Top, Bottom and L/S SI Portfolios
Jan 2004 - Jan 2013 vs. R3000
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13. Live Performance slice only
Notes: the long-only side of the book suffered ~22% draw down in mid-
2011 in line with the R3K while the market-neutral strategy continued to
accumulate profit.
The largest L/S draw down (~14%) hit later in 2011 at the market
turnaround
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14. Short Interest as Stock-ranking Signal
• Introduction – what is a short sale, and why should quants care
• StarMine Signal overview, Out of Sample and Live Returns
• StarMine SI Model Formulation
– Baseline ratio
– Institutional Ownership adjustment
– Merger arbitrage
– Dividend payments
– Short Squeeze Indicator
• Recap – universe selection, correlations and turnover
• Q&A
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15. Baseline ratio
Naïve Baseline Ratio: Rank [ ], per company
– Low (high) short interest levels predict out (under)-
performance in US Equities, with low correlation to commonly
used quant factors (value, price momentum, etc)
– Academics have been writing about this anomaly for years
(selected refs: Diamond 1987, Dechow 2001, Desai 2002,
Arnold 2005, Asquith 2005, Engleberg 2010)
– We propose that the short interest “anomaly” is a combination
of market (in)efficiency and biases: SEC requires disclosure of
short positions (as a measure of transparency) semi-monthly
and investors believe that short sellers are good stock
pickers.This leads to herding as people follow the “smart money”
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16. Decomposing short interest quintiles by institutional
ownership reveals an interaction
least held by most held by Mean return
institutions Pct held by Inst. 3
2 Quintiles 4 institutions by lvl of short
most heavily shorted 0.06% 0.12% 0.34% 0.24% 0.82% 0.31%
2 0.49% 0.38% 0.38% 0.35% 0.83% 0.49%
Short Interest Quintiles
3 1.03% 0.37% 0.56% 0.39% 0.93% 0.65%
4 1.38% 0.70% 0.66% 0.52% 1.19% 0.89%
least shorted 1.14% 1.26% 0.79% 0.71% 1.38% 1.05%
SI spread 1.08% 1.14% 0.45% 0.47% 0.56%
outperformance underperformance
Mean one month
return for all stocks in
each bucket
As might be expected, high levels of short interest in stocks with low institutional ownership
(which we use a proxy for „hard to borrow‟) underperform heavily shorted stocks with high
levels of institutional ownership.
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We view these as „high conviction‟ shorts, which will also clearly be more difficult to trade in
practice.

17. Event Study: M&A arbs artificially drive down the SI
Rank of „acquiree‟ companies
In the 30 days surrounding an acquisition announcement we see an
increase in the short interest level of the acquiring company that is typically
uncorrelated to any changes in fundamentas.
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18. Large dividend payments drive short sellers
(temporarily) out of stocks
Event Study/Histogram: What is the distribution of large dividend
payers across short interest deciles?
Too many
lightly shorted
companies
implies
artificial short
covering on
ex-date
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19. StarMine provides a short squeeze indicator
independent of the SI model rank to help users
algorithmically identify potential short squeezes.
“Short Squeeze” means different things to different people. We look for a
large forward 1-month “draw-up”.
What is F1M draw-up?
The maximum % price
increase
from the first day of the period.
e.g., for HOV on 2007-7-31:
F1M draw-up = (16.22 - 11.95)/11.95
= 35.7%
Our goal is to predict the rank of F1M draw-up, rather than an absolute value.
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20. StarMine short interest model rank informs
price direction while the short squeeze
indicator informs short term upside volatility.
Short Squeeze
Indicator : risk of one
month drawup
Short Interest model
rank (1-100): relative
to country, sector, or
market cap quantile
Model scores update
semi-monthly with short
interest data, monthly with
ownership, and as reqd by
M&A and dividends
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21. Recap: The StarMine Short Interest Model is a buy-side
sentiment signal based on the hypothesis that short sellers
are value-oriented investors making directional price bets.
Rank Correlations between SI and other StarMine models
Annual Spread Sharpe ValMo ARM PriceMo EQ RV IV
Short 13% 1.17 0.216 0.022 0.060 0.101 0.240 0.172
Interest
L/S Turnover
110% per year
US securities
top 98.5% by
marketcap
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22. QUESTIONS?

23. Appendix
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24. What is a short sale?
A stock “short sale” is a stock sale where the purchase price is
not determined until AFTER the sale takes place.
BD/II/Owner Short Seller Open Market Buyer
“borrows” stock Sells stock at t=0
t=0 (pays borrow rate) day‟s price
Open Market Seller
t=time to “returns” borrowed Buys stock at
cover stock t = time to cover‟s
price to “cover” the
shares that need to
be returned to the
*exceptions are hedges and arb strategies Owner
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25. Small cap performance exceeds large cap
performance, but using the “cap neutralized” StarMine
model rank does not hurt performance.
We provide
a market
cap neutral
rank as part
of the
model
output
• Leadership switched to Mid Cap in 1Q2009 after large drawdown
• Large Cap performance has suffered since 1Q2009
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26. We found that Days to Cover, a commonly
used predictor of short squeezes, does not
work better than a random indicator.
• Days to cover = “Short Ratio” = # Shares Short / Avg Daily Volume (T1M)
• Our primary measure is hit rate (0-1, higher is better) - the number of stocks
actually in the top decile of F1M draw-up / number of stocks predicted to be
in the top decile. This is a measure of how good your highest-conviction
predictions were.
•
Hit Rate for
Random Model
= 0.1
We have developed an indicator that has a significantly better hit rate.
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