Editor’s note: The following is primarily for sophisticated investors and, even then, not investment advice. For the rest of the readers, hopefully it is an interesting lesson on how markets often don’t make sense.
Truth Social, the Donald Trump social media platform, has been a fascinating stock to watch. DJT has almost no revenue and loses money, yet reached a market cap as high as $8B in late March.
By mid April, the stock was down 2/3. Yet, just two weeks later, it has doubled again and is now at $48 ($6.5B cap).
Why so volatile? It is much like GameStop, where cult-like retail buyers are fighting professional short sellers.
As many probably know, there is an added element where, if the valuation stays high, Trump can sell stock to pay off some of his legal judgments.
Thus, some of his supporters are willing to lose money in the long term, if necessary, to keep the stock elevated through the election.
Of course, institutional investors see an incredibly overvalued stock that seems like an easy short…except for one thing: the cost to borrow it.
Hard to Borrow
I will try my best to simply explain a highly technical issue. When one shorts a stock, mechanically, you are borrowing it from someone who owns it. You are selling their shares with a promise to buy them back later, hopefully at a lower price.
If you want to short say Walmart, it is very easy to borrow. There are plenty of owners, and they are in no position to demand compensation for their stock or you will go ask another holder instead. Thus, the cost to borrow Walmart is negligible.
However, if you want to borrow a stock that a lot of people are skeptical about, the demand for shares to borrow can be very high. In this case, owners can demand payment for lending their shares. Investors call this “hard to borrow“, or HTB.
For a typical popular short, the cost to borrow might be an extra 3-5%. For names with a lot of skepticism, it can be over 10%. Many insuretechs have been north of 20% over the last few years.
For context, if a stock is at $50 and the cost to borrow is 10%, then, if a year from now the stock is at $45, you only broke even after your HTB costs, as the HTB cost negated your gain from the stock falling.
So it can be very difficult to make money shorting HTB stocks. In extreme cases, you see stocks go over 100% HTB, but that was during the internet bubble or the mortgage crisis.
Recalling Stock
OK, now I’m going to get slightly more technical before getting to the heart of the story. DJT put out a press release last week urging shareholders to “recall” their stock.
What does this mean and why does it matter? If you own stock, there is a good chance the broker lends it to short sellers to make extra fees.
However, there is a tool shareholders can use to prevent this. If you tell your broker to recall your stock, that means it can’t be lent out anymore.
This reduces the supply of shortable shares and drives up the HTB cost. Now, if you do this, you lose out on the income, but it can be strategically worth it to pressure shorts into caving if the cost to borrow gets too high.
What Trump is doing is asking his fans to give up their HTB income in order to pressure the shorts. This will make the stock go up in the short term, but, at what cost?
DJT HTB Rate
Do you want to guess what the HTB rate is for DJT stock? No, not 50%. Try again. 100%? Not even close! 200%? You’re getting warmer…
It’s been reported that the borrow rate for DJT is over 500%!!!
I have never heard of a rate this high. I’m sure it’s happened, but not that I can recall. What does this mean?
First, Trump is asking his fans to act against their own economic interest by recalling their shares. Why would they give up a 500% return just to squeeze the shorts?
At the end of the day, the stock price will be what it will be. Things like HTB can affect the path to getting there, but that is all.
So if you are going to give up the guaranteed return from HTB, you need to be awfully sure it will significantly affect the short term stock price to compensate you.
In this case, it means the stock would have to go to $300 for you to be better off!
As that is extremely unlikely, you’d have to be a fool to recall your stock. I could even argue there is a D&O case to be made against DJT for encouraging holders to recall their stock.
But forget about the current shareholders, what should you do?
The Case To Buy & Lend DJT
Hopefully, some of you have figured out this next part by now.
Nothing prevents you or me from coming along and buying DJT and lending it to the shorts.
Why would I do that? Because if the HTB rate remains this high, I can’t lose, even if the stock goes to $0!
Think about it – the most I can lose on my stock is 100%. If I can continue to lend it at 500%, I come out well ahead.
This shouldn’t be possible, right? It seems like free money! It mostly is. That’s how broken the market is for this stock.
And, of course, if the short squeeze works and the stock continues to rise, you will make 500% plus the stock appreciation.
Caveats
Now, there are some important caveats.
First, the lend rate has to stay above 100% for a year (or, alternately, over 500% for 1/5 of a year). HTB rates change daily based on supply and demand.
The people who are short don’t plan to be short for a full year. They are paying effectively 2%/trading day, so they are hoping it goes down 50% in two weeks and they still come out ahead.
Which leads to the next caveat. Even if the rate stays at 500% all year, if the stock collapses, you may not make 100% on your purchase price.
Quick example. You buy at $48. Tomorrow, the stock drops in half and stays there for a year. For the rest of the year, you will be earning 500% on $24, which is equivalent to 250% on $48.
So, if the stock falls quickly, you may not make 100% over the course of a year, which means you can still net lose if the stock goes to 0, even if the HTB remains at extreme levels.
On the other hand, the stock could go up near term due to the recalls, in which case, you would get paid 500% on an even higher price!
Could the HTB Rate Fall?
Of course, it could. If enough smart traders try to execute the strategy I laid out, the supply of stock available to the shorts will increase and thus the HTB price will drop.
What else could cause it to fall? DJT could issue more shares to raise capital. This would also increase the supply of lendable stock and bring down the HTB rate.
Also, if Trump sells his own shares to raise money for his legal bills, the new buyers may be more willing to lend.
However, I suspect it will remain >100% for quite some time, barring a quick collapse (e.g. to below $10) of the stock price.
An Attractive Risk Arbitrage
Due to some of the caveats I laid out, you can’t call this a true risk-free arbitrage. That would require perfect knowledge that the HTB rate will stay elevated for months or even years.
However, there is good reason to suspect you can make more in HTB income than you could lose in the stock.
Note, this trade really is only for professionals. You need real time access to HTB rates to be able to continually calculate your expected return and decide whether to keep the position on.
I am unlikely to do it myself for that reason and would caution anyone who is excited about this and wants to imitate it to consider whether they have the knowledge to execute it.
That said, it is a very fun paper trade to put on and monitor. I suspect those who buy and lend the stock here will come out net ahead, while those who recall their stock will suffer all the losses.