Blog - Investing Notes

August 4, 2005 – Could Failures Point to Success?

The Regulation SHO threshold security lists for the NASDAQ and NYSE flag those stocks for which a significant percentage of short sales are not balanced by borrowed shares. Our blog entry of 8/2/05, in summarizing recent academic research on short selling, states that: "Appearance on the Regulation SHO threshold list suppresses subsequent short selling, but it does not significantly affect future returns for stocks priced $5.00 and above. However, stocks on the threshold list priced below $5.00 do have significantly lower future returns." But what happens to returns when stocks come off the threshold list? Does coming off the list release pent-up shorting demand, driving price down? Or, does it indicate that shorting has been overdone, with prices subsequently drifting up? Let's check:

To construct a sample of stocks coming off the threshold list, we retrieve the daily NASDAQ threshold lists for June 2005 and identify those stocks that disappear from the list during June 2 through June 30. We assume that by June, the threshold list maintenance process has matured since implemented at the beginning of 2005. We find that:

• 383 securities appear on the NASDAQ threshold list during June 2005.
• There are 192 exits from the list (one stock exits twice).
• Based on data from Yahoo! Finance, 136 of the 192 exits involve stocks priced less than $5 at the time they leave the list (or currently if no historical data is available). Many of these low-price stocks are OTC or Pink Sheet issues.
• 32 of the 192 exits involve stocks priced over $10 at the time they left the list.
• Yahoo! Finance has historical price data for the stocks in 138 of the 192 exits. Most of those stocks without historical data have current prices below $0.25.

The light blue bars on the chart below show the average returns for all 138 stocks for which Yahoo! Finance has historical price data at 1 day, 3 days, 5 days, 10 days and 21 days after they leave the NASDAQ threshold list. The dark blue bars show the returns for the 30 out of the 138 that have prices of at least $10 when they leave the list. The green bars show, for comparison, the average returns over the same intervals for the NASDAQ Composite index for all days from June 2 through June 30.

Results suggest that prices rebound for stocks coming off the NASDAQ threshold list. Standard deviations for the entire sample of 138 stocks are very large compared to the average returns. Standard deviations for the 30-stock subset of stocks priced over $10 are moderate compared to the average returns, and the sample size for this subset is modest. However, given the size of the excess returns, picking through the stocks leaving the threshold lists may be worthwhile.

For related research, see Blog Synthesis: Short Selling and Short Interest.