Meme Stocks and Short Sellers
Ask A CIO #47
Meme stocks are back! Not AMC and Gamestop though – those are very 2021. It’s a new set of companies this time around, with the likes of Kohl’s, GoPro, and Opendoor Technologies seeing major spikes in their stock prices and trading volumes.12
From a pure spectator’s perspective, I’ll admit to finding the whole thing both fascinating and highly entertaining. I can appreciate the delicious irony of everyday investors, unknown to one another, banding together in unruly collectives to take advantage of hedge funds and their short positions.3
But as a participant in capital markets, I genuinely appreciate the role that short sellers play.4 It is hard to be a consistently successful short seller. Like, really hard (I’ll come back to this point).5
And so, I’d like to use this week’s newsletter to offer a brief commentary on short selling and its role in markets.
It’s popular to think of short sellers as enemies of companies and other investors alike. Yes, short sellers profit when stock prices decline. And yes, some firms are known to loudly and/or obnoxiously criticize their target companies.6 But if we care about market efficiency, if we care about price discovery, if we believe that markets should reflect reality (sometimes I’m not sure we’re all on the same page on this one), then we should also probably acknowledge that short sellers help keep markets functioning.
Short sellers are, by the nature of their work, motivated to find and challenge inflated valuations. They look for overpriced companies with weak fundamentals, and their market participation contributes to correcting those pricing imbalances. At their most effective, short sellers have been whistleblowers, actively exposing some of the most infamous frauds, including Enron and Wirecard.
To put it bluntly, other investors rely, directly or indirectly, on short sellers to do the dirty work of surfacing red flags and company concerns. The short sellers are not always right. But when they are, their work benefits the rest of the market.
Now let’s circle back to my earlier comment on the difficulty of being a consistently successful short seller. For a fund, the mechanics of selling short a stock are: 1) borrow the stock from a prime broker; 2) sell the stock in the open market; 3) repurchase the stock; 4) return the stock to the prime broker.
It all starts with locating shares to borrow from the prime broker. Some stocks are easy to borrow, and others are hard – they literally get classified as “hard to borrow.” It does occasionally happen that an investor wants to sell a stock short, but there’s just no borrow.
Once the shares are located, the investor has to pay to borrow the shares. This borrow fee can be below 1% per year, or it can be over 100% per year. The borrow fee is unsurprisingly driven by supply and demand (i.e. higher fees when there is high demand to borrow coupled with low supply), and it can change during the period in which an investor is short the stock. Consequently, for a short seller, investment timing is usually really important.
And then there’s the payoff profile for short selling. For all of this trouble, the maximum gain on each short position is the value of the stock at the time of the short sale. Selling a stock at $50? If the stock goes to zero, which is the lowest it can go, the gain, excluding borrowing costs, is $50. The potential loss, however, is infinite – the stock can theoretically rise in value to any price (see aforementioned meme stocks). Consequently, for a short seller, appropriate position sizing is also really important.
Given the challenges, why do some investors choose to be short sellers? Well, I’ve met my fair share of stock pickers over the years, and from what I’ve seen, active (not necessarily activist) short sellers are just built differently. Short selling is, as noted above, an inherently difficult task. Doing it well requires strong fundamental research capabilities coupled with strict risk discipline and a good pulse on markets from a structural standpoint. Of course, it also helps to be skeptically inclined.
Short sellers get a bad rap, but they apply (or at least they try to apply) discipline to markets in real time. They may not prevent bubbles, but they do at least make it harder for bubbles to grow unchallenged.
There’s money to be made, so it’s hardly an altruistic endeavor, but man, there are so many easier ways to make money! U.S. equity markets have been pretty much a one-way street since 2009. Short sellers choose to go against basic market tendencies. And for that, I think they deserve some credit and recognition.
Thanks for joining, and as always, reach out to: askacio@ivyinvest.co!
See you in two weeks,
Wendy
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Click below to create an account and learn more about our fund.Wall Street Journal, July 23, 2025: Meme Stock Mania Returns. Meet the New Class. - WSJ
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The cautionary tale of shorting meme stocks was immortalized in the 2023 movie, Dumb Money. For what it’s worth, by all accounts from other institutional investors, the real-life hedge fund portfolio manager was well-respected and well-liked across the industry.
Buena Capital Advisors LLC, d/b/a Ivy Invest, does not engage in short selling or securities lending activities.
Here I’ll draw a distinction between short selling to hedge long positions and short selling to produce absolute returns. There’s certainly plenty of overlap, but I’m primarily referring to the single stock short sellers that seek to generate absolute returns from those positions.
Some of the louder, more activist firms probably deserve their reputation.