Trump Media Fueled Meme-Stock Mania: A No-Go Zone for Short Sellers?

Trump Media stands as one of the market's most challenging and costly short trades at present. Investors considering a short position in it are confronted with exorbitant annual financing fees exceeding 150% to borrow shares, compounded by the risk that the stock's meme-driven volatility and dedicated fanbase could inflict further losses. According to S3 Partners' data, the recent public entity has become the priciest stock in the US to short, with short interest surpassing the $100 million mark, or nearly 11% of its outstanding shares.

The short trade is expensive in part because there's a tiny amount of shares available to borrow and strong interest in betting against the company as shares hold onto gains, according to Ihor Dusaniwsky, managing director of predictive analytics at S3 Partners.

Shorting a stock typically requires borrowing and then selling shares, hoping to buy them back at a lower price. However, shorting the freshly debuted DJT, which emerged from a Special Purpose Acquisition Company (SPAC), presents unique challenges. Common lenders like institutional investors and ETFs don't hold large positions in SPACs, and they're not common in major indexes, leading to a limited supply of shares to borrow. Additionally, retail investors, who often own SPAC shares, usually don't lend their stock for short selling. Due to these factors, and the high demand to short Trump Media, borrowing costs are exceptionally high, making it one of the costliest stocks to short in the U.S. market.

So far, betting against Trump Media has been an unprofitable decision. The surge in the company's stock on Tuesday led to an estimated $61 million in paper losses for short sellers, pushing their total mark-to-market losses to $158 million for the year, as reported by S3 Partners.

On Monday, Trump told reporters that "Truth Social is doing very well. It's hot as a pistol and doing great.” On Tuesday, he posted "I LOVE TRUTH SOCIAL, I LOVE THE TRUTH!," on the platform.

Investors looking to bet against difficult-to-short stocks may buy put options as an alternative, to profit if shares fall back or upside movement. Options trading linked to Trump Media & Technology experienced a significant surge on Tuesday, eclipsing past activity in the SPAC previously associated with the social-media operation, says Cboe Global Markets's Henry Schwartz.

Midday volume on Tuesday of both puts and calls at noon was more than five times the full-day average over the past 20 days, data compiled by Bloomberg show. The most actively traded contracts were $80, $90 calls, and $50 puts expiring Friday.

The company's stock price so far has reflected little of the company's actual fundamental operating performance, which is why it has drawn mainly small-time investors either trying to support Trump or aiming to cash in on the mania, instead of big institutional and professional investors.

"Today's price action and valuation are completely out of kilter with the underlying business and its prospects," said AJ Bell investment analyst Dan Coatsworth.

The company's market capitalization exceeded $10 billion on an undiluted basis at its session high of $79.38 a share. This is an astonishing figure for a business that announced an operating loss of $10.6 million for the first nine months of 2023 on revenue of just $3.4 million.

Research firm Similarweb estimates that Truth Social had roughly 5 million active mobile and web users in February. That's far below TikTok's more than 2 billion and Facebook's 3 billion.

The former president is dealing with multiple legal challenges while running for president again. He is involved in four criminal investigations that could be a potential shock to the stock price, two of which relate to attempts to alter the 2020 election outcome. Additionally, he has been hit with two civil penalties totaling over $500 million in 2023. The most significant financial risk comes from a $454 million civil fraud judgment against him for overvaluing his assets. While appealing, he must pay a $175 million bond by April 4, but if the appeal is unsuccessful, he'll owe the full $454 million plus interest.

Nevertheless, shorting the stock of Trump's company is highly risky, partly due to the potential for a short squeeze. Retail investors have demonstrated they can collectively drive up a "meme stock" price. With only about 28 million shares of Trump Media available for trading, and Trump himself owning over 60% (roughly 78 million shares), the market is especially susceptible to volatility driven by concerted efforts of investors. This scenario can lead to rapid price increases, inflicting severe losses on those holding short positions.