Short interest drops, U.S. stocks investors feel squeeze

By Leah Schnurr

NEW YORK (Reuters) - Bearish bets in U.S. stocks dropped sharply at the end of July for the first time since mid-May, the exchanges said on Tuesday, suggesting short investors have been forced to abandon their bets in the wake of the recent hefty rally.

The data also suggested negative sentiment was on the decline as the broad S&P 500 index racked up a second leg of the rally that began in early March when the index hit 12-year lows.

Investors who sell securities short seek to profit from bets the shares will fall. Short-sellers borrow the shares and then sell them in the hope of buying back the shares at a lower price, pocketing the difference.

However, if prices continue to defy gravity, a "short squeeze" can occur where the investor is forced to buy the share at a higher price and swallow the losses.

In the two-week span covered by the exchanges' data, the S&P 500 jumped nearly 6 percent, fueled by enthusiasm over better-than-expected second-quarter corporate results.

Analysts have questioned whether the rally has been the result of improving fundamentals and how much has been short-sellers forced to buy back their positions.

"The rally is more about shorts throwing in the towel than it is about investors becoming exuberant about stocks again and being interested in the long, fundamental story," said Justin Golden, a strategist at Macro Risk Advisors in New York.

"This is a negative because a rally that is being led by low quality names that are being shorted in the market is not a rally that bodes any meaningful confidence," he said.

Short interest on the New York Stock Exchange tumbled 10.3 percent in late July as short bets fell to 14.03 billion shares compared to a revised 15.64 billion shares as of July 15.

Short interest was equivalent to 3.7 percent of total shares outstanding, the exchange said.

On the Nasdaq, short interest fell 5.1 percent to about 6.78 billion shares from 7.14 billion shares over the same period.

The Nasdaq said the short interest represents 3.1 days at average daily volume, compared to an average of 2.9 days for mid-July.

Since mid-May, short interest has increased as investors bet that stocks were overdue for a correction, but so far pullbacks have been shallow and short-lived.

Golden noted that the data does not mean short interest won't pick up again, but it is more advantageous to place short bets in an optimistic market as it sets the stage for a potentially bigger reward if prices fall again.