A Very Interesting New ETF, The 'Short Squeeze' ETF

Matt Thalman - INO.com Contributor - ETFs

On March 21st shares of The Active Alts Contrarian ETF (NASDAQ:SQZZ) began trading. SQZZ is the first ETF of its kind and opens the door for investors looking at investments from a slightly different angle. SQZZ is in a nutshell a 'short squeeze' Exchange Traded Fund.

First I will explain how shorting a stock works and what a 'short squeeze' is and then I will discuss SQZZ and why I like it.

What Does It Mean To 'Short' A Stock and What's A 'Short Squeeze'

If you don’t 'short' stocks very often, the concept of a 'short squeeze' and how this ETF will make money may be a little confusing. But I will start at the beginning and try to explain it all.

First, when a stock is sold 'short' that means the investors believes the price of the stock will move lower, not higher. If you buy stocks believing the share price will be higher in the future, what most people typically do, that is called going long on a stock. Hence, the phrase, 'going short' a stock when you think the share price is going to decline.

As for a 'short squeeze', that is when a stock is highly shorted; say 15% or more of the shares are sold short. The squeeze comes into play after the stock makes an abrupt move higher for whatever reason, but usually driven by a news event or earnings release. The initial move could be as little as say 5% or even less and when this happens the investors who are 'short' the stock begin to get out of their trade.

Now, if you are still with me, here is where it may get a little confusing. When you 'go long' a stock, you buy at on January 1st at $5.00 and sell on February 1st at $6.50, making $1.50 per share. When you 'short' a stock, you sell it at $5.00 on January 1st, this is actually when you open the position, and you buy it at $3.50 on February 1st, this is actually when you are closing your position, making $1.50 per share.

In general terms, the act of buying shares puts upward pressure on the price of a stock because demand for the stock is increasing. The more people you have that want to buy shares, the higher the price will go until the number of people wanting to buy the stock levels off with the number of people wanting to sell the stock. Well the same thing happens during a 'short squeeze'.

When the 'short' investor see's the stock price jump 5% and they realize they have now lost 5% of their investment, they decide they want out. In the process of getting out of the stock, they end up 'buying' shares which only pushes the stock price even higher. When a stock is only slightly 'shorted' say 10% or 15%, the buying demand may not be that great and the squeeze may not be too severe. But when a stock has a 'short' interest of say 30% to 40%, the squeeze can be ridiculous as a massive number of investors bail on a stock all at the same time.

Why I Like SQZZ

So now that we understand what a 'short squeeze' is, the way The Active Alts Contrarian ETF (NASDAQ:SQZZ) is attempting to make money is by finding stocks that are highly shorted. When it finds a stock that says it has 30% short interest, it will buy shares of that stock and hold them until either the short interest declines back to a more reasonable level or the stock pops, causing a short squeeze to occur.

The idea is that the squeeze will cause the stock to move much higher than it normally should, and when this happens management will sell the shares and make a handsome profit. This is not the best investing idea I have ever heard, but also not the worst.

So if that’s not great, why do I like SQZZ? Because while SQZZ waits for a stock it owns to experience a short squeeze, it's also collecting a nice little 'lending' few. So when a stock has a lot of 'short' interests in it, investors who want to short the stock pay a small fee to their bank or broker for giving them the opportunity to short the particular stock. In most cases, the bank or broker keeps the fee for themselves for providing that service to the investor.

But, since SQZZ plans to own large amounts of highly shorted stocks, it has cut a deal in which it will get part of the fee the bank or broker is collecting. This fee will be paid to SQZZ investors in the form of a dividend.

At this time we don’t know exactly how much this dividend will be, but it is certainly a nice little feature of SQZZ and the main reason I like the ETF. But, investors need to know SQZZ will likely experience some volatility and big moves higher and lower because it is investing in stocks that other very intelligent people believe will decline in price. SQZZ could easily see its value decline when stocks that it owns fall on troubled times.

Furthermore, The Active Alts Contrarian ETF (NASDAQ:SQZZ) is not cheap; the expense ratio is 1.95%, the dividend will need to be higher than that just to break even while you wait for a 'short squeeze' to occur. And that is the key with this ETF. A 'short squeeze' will need to happen and somewhat often in order to make a solid return on this investment. The problem is, 'short squeezes' don’t happen all that regularly, especially outside of earnings season. So while I like the idea of SQZZ, I can't say I will be buying shares anytime soon.

Matt Thalman
INO.com Contributor - ETFs
Follow me on Twitter @mthalman5513

Disclosure: This contributor held long positions in Apple, Tesla, Intel, Google, Amazon.com, Facebook, Priceline and Microsoft at the time this blog post was published. This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.