March 19, 2009 / 12:45 PM / 11 years ago

Short side of Citi proves elusive, triggers squeeze

NEW YORK (Reuters) - Traders betting that shares of Citigroup (C.N) and other beaten down financial stocks will fall are finding it extremely difficult to borrow shares needed to make that bet, market participants said on Wednesday.

Citi, which has received $45 billion of capital from the U.S. government, has seen its shares more than triple since their $1.02 close on March 5, as the outlook for the banking system has improved and short sellers have been forced to buy back shares.

But traders and other market observers are saying this is a unique kind of short squeeze, because in just a matter of days shares of Citigroup have become almost impossible to borrow.

“Citigroup is the toughest short these days,” said Rich Gates, founder of TFS Capital, which runs a short-long market neutral fund.

Investors who sell securities “short” borrow shares and then sell them, waiting for the stock to fall so they can buy the shares back at the lower price, return them to the lender and pocket the difference.

Other companies with shares that have become increasingly difficult for short sellers to borrow include U.S. government-controlled home-funding companies Freddie Mac FRE.N FRE.P and Fannie Mae FNM.N FNM.P, and AIG (AIG.N), the former insurance giant that has received up to $180 billion in U.S. government bailouts, according to DataExplorers Ltd, a firm that tracks stock lending activity and short selling.

According to the firm’s data, there was a sharp jump in the percent of lendable shares financial institutions had out on loan to short sellers on February 27 — the day the U.S. government committed to holding up to 36 percent of Citigroup’s common shares in a deal to bolster the fallen financial giant’s capital base.

On February 26, about 12.2 percent of Citigroup’s lendable shares were on loan, but that jumped sharply on February 27 to about 51.5 percent, according to DataExplorers.

But that jump also coincided with a sharp increase in shorting of Citigroup shares.

“Short sellers probably came in and shorted, saying this is another bailout and it’s going to be more bad news,” said Bill Rhodes, founder and chief investment strategist at Rhodes Analytics in Boston.

On February 26, according to DataExplorers figures, about 2.5 percent of Citigroup’s shares outstanding were out on loan to short sellers and other people who short stocks, but as of Monday about 15 percent of Citigroup’s shares outstanding were out on loan.

Now, the jump in short interest in Citi shares has coincided with positive news about the company and the banking sector from executives, triggering potential for a short squeeze. But also, as of Monday about 76.1 percent of lendable Citigroup shares were out on loan to short sellers, making it nearly impossible to locate the stock.

“(My brokerage firm) said you can’t short Citi and Freddie, and they said Citi particularly is very hard,” Gates said.

SHORT SQUEEZE COULD LAST

This also coincides with rules requiring short sellers to prove in 13 days that they are able to make delivery of the shares they have shorted. If a short seller placed a bet around March 2, and didn’t immediately locate the stock for delivery purposes, they would be looking to find it this week.

“It creates a short squeeze,” Rhodes said. “If you didn’t cover immediately and it took you a couple of days to cover, then now is the deadline, so you’ve got to buy in. If people shorted in the days after (March 2) they’ll also be caught in it over the next few days.”

A similar stock loan pattern exists in shares of Freddie Mac, according to DataExplorers. On February 16 about 58 percent of lendable Freddie Mac shares were out on loan, but by Monday that figure had risen to 78.3 percent, with much of the rise coming in the past week. There has also been a slight increase in shares outstanding on loan for Freddie Mac, according to DataExplorers.

In shares of AIG, about 48 percent of lendable shares are out on loan as of Monday, compared with 28.5 percent on February 16. For Fannie Mae, about 31.5 percent of lendable shares were on loan on Monday, compared with 25.7 percent on February 16.

Traders said such worries about shorting Citi shares were one reason option volume in Citi skyrocketed on Wednesday.

“A lot of shorts who were covering the (Citi) shares are now being told ‘we no longer have the shares available’ so someone somewhere may be sucking shares out of the market,” Gates said.

Reporting by Rodrigo Campos and Emily Chasan

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