Volkswagen short squeeze, federal interest rate cut, short squeezing
Michael Probst/AP
The value of Volkwagen shares is seen at the stock market in Frankfurt, Germany.

Porsche Purchase of Volkswagen Stake Causes Short Squeeze—the First of Many?

October 29, 2008 06:12 PM
by Anne Szustek
Porsche’s announcement that it bought a larger stake in VW prompted unusual market activity in Germany. Is this a precursor of a Wall Street trend?

Bear Market Upsurge May See Rise in Short Squeezes

Volkswagen shares soared 286 percent in the week ending Tuesday, closing at a record high €945 (about $1,198) on Tuesday. All 29 other stocks traded on Germany’s DAX Index have gone down in that period.

The reason VW shares traded so high was not a sudden surge in car sales, but rather heavy accumulation of shares by rival carmaker Porsche, resulting in few shares available for normal market trading. As VW’s stock price rose, traders who had sold VW’s stock “short” were forced to buy shares to reverse their earlier transaction. 

A short sale occurs when a trader sells shares it does not own, hoping to re-purchase the shares later on at a lower price.

Some market observers believe the short squeeze phenomenon may become more common, with global stock prices at five-year lows and short sellers placing aggressive bets against the survival of many companies.

Porsche announced on Sunday that it effectively controlled 74.1 percent of VW stock—holding 42.6 percent of the carmaker’s common stock and 31.5 percent in cash-settled options. This left less than 6 percent of Volkswagen stock as “float,” or stock not held by majority owners or insiders.

This prompted a surge of buying of VW stock, driving up the stock price nearly fourfold. Porsche denied any wrongdoing and asserted that its announcement gave ample time to short sellers to back out of their positions.

On Wednesday, Porsche agreed to sell a small part of its stake to restore liquidity to trading in VW shares; as a result, VW shares lost nearly half their new value, but were still well above where they traded a week ago.

“In order to avoid further market distortions and the resulting consequences for those involved, Porsche SE intends … to settle hedging transaction in the amount of up to 5 percent of the Volkswagen ordinary shares,” Porsche said in a statement cited by Reuters.

Market observers suspect that some major financial institutions suffered heavy losses from the short squeeze, yet none have admitted it.

“Clearly there has been a colossal amount of money lost,” a London hedge fund manager with investments in Germany told Reuters.

Background: Short squeezing

Short squeezes can occur when the price of a stock gets pushed up strongly by a strong demand buoyed by a shortage in supply of shares. As Investopedia explains, “Short squeezes occur more often in smaller cap stocks with small floats,” or shares freely traded on the market.

Short squeezes prompt panic buying by short sellers, who need to buy back the shares they had sold short, further feeding the stock’s fast price rise.

Stateside, shares that could be “short squeeze candidates,” according to blog Ahead of the Ticker, are upscale fast-food chain Chipotle, box retailer Target, apparel chain Aeropostale and engineering and construction firm KBR. The first three have major share buy-ups in the pipeline, and all four have significant short interest.

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