How likely is it that AMC stock will undergo another short squeeze?

Following the large drop in the share price, short selling in the AMC has eased. But can a short squeeze still occur? AMC, which is closely associated with the recent short squeeze phenomenon, saw a decline in interest in short selling after the conversion of preferred shares to common shares, which diluted the stock’s free float and lowered the share price.

Despite some remaining short interest, the current setup in AMC is less favorable for a short squeeze due to the stock’s all-time low price, but high trading volume and technical factors contribute to ongoing volatility.

The Short Squeeze Setup

First, for a short squeeze to occur in the stock market, a heavily short-sold stock must experience a rapid and significant rise in price. This forces short sellers to cover their positions by buying the asset, which in turn drives the price even higher.

While there is no guaranteed formula for triggering a short squeeze, certain conditions and settings can increase the likelihood of one occurring, for example:

High short selling: This means that a significant part of the stock’s free float (the total number of shares available for trading) has been sold short by investors betting on a price decline. The higher the short rate, the greater the potential for a short squeeze.

Limited number of shares available: When there are not enough shares to trade or borrow to sell short, it can amplify the effect of a short squeeze. When fewer shares are available, it can be more difficult for short sellers to cover their positions without dramatically driving up the price.

Cost of borrowing: A shortage of shares available for borrowing generates higher fees for short sellers. When there is too much demand for short trades, borrowing fees can skyrocket, making short sellers more vulnerable to covering positions.

Technical breakouts: Stocks trading near support levels or heavily oversold can attract both short-term and long-term traders, leading to increased buying pressure.

Liquidity and trading volume: These two factors lead to greater volatility in price movements, usually motivated by a specific catalyst that drives investor sentiment.

AMC’s current settings

The recent phenomenon of short squeezes has been closely associated with stocks like AMC Entertainment (AMC) – Get Free Report, mainly due to its huge popularity among private investors during the meme frenzy that started in January 2021.

In fact, as described in the company’s Form 10-K, this represents one of the key risks associated with its shares:

“Volatility in our shares of our common stock through a “short squeeze” in which coordinated trading activity causes a spike in the market price of our common stock as traders with a short position make market purchases to avoid or mitigate potential losses, investors buy at elevated prices unrelated to our financial performance or prospects, and may subsequently suffer substantial losses as prices decline when the level of short covering purchases has dropped.”

Until very recently this year, AMC met all the criteria indicating a short squeeze set. Following the conversion of APEs (AMC preferred units) into common shares, which resulted in the dilution of the float and consequently depressed AMC’s share price, the short-term interest rate has decreased significantly.

According to Ortex data, about 12.5% of the free float is currently short, with a borrowing cost of 6.3% and a utilization rate of 59%.

These figures are markedly different from the period before the court approved the settlement for the implementation of the APE conversion on August 11, when AMC had a short-term interest rate of around 27% and loan fees had skyrocketed to a staggering 1,000%.

Conclusion

A significant portion of the high demand for short selling of AMC came from arbitrage traders betting on the price convergence between AMC common stock and preferred stock – with common stock in the short end of the trade. When the conversion took place, the value of AMC shares fell, resulting in profits for short sellers.

While there is still a significant level of short interest in AMC shares, the current setup is less favorable for a short squeeze. This is mainly because the AMC has already reached its all-time lows, making further downside potentially less appealing to short sellers.

However, it is important to note that trading volume has been consistently high throughout September (illustrated by the green and red bars in the chart below), suggesting ongoing volatility and persistent risks for short sellers. Moreover, technical breakpoints indicate that AMC shares are deeply oversold, further adding to the complexity of the situation.

It is worth noting that the investment thesis on AMC has shifted towards a focus on the company’s fundamentals rather than simply aiming to profit from crushing excess demand.

The cinema chain has strengthened its liquidity position by issuing new shares and has reported strong quarterly cash results. These results are expected to bring the company back to pre-pandemic revenue levels in the near future.

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