How Short Sellers Lost $1.4 Billion in One Day Betting Against Tesla

Whether you like him or not, you have to admit that Elon Musk, the eccentric CEO of electric car manufacturer Tesla NASDAQ: TSLA , can certainly provide some remarkable headlines. After he infamously dropped a shocking tweet stating that he was taking his company private in a buyout offer, Musk was dealt a $40 million dollar fine from the SEC and kicked off of the board. This apparent attempt to combat Tesla short-sellers was clearly not successful, but it appears that Musk might have gotten the last laugh. On October 23^rd, Tesla Inc. reported positive Q3 earnings and took short sellers to the cleaners in the process.

Tesla posted a surprise profit on its Q3 earnings and sent shares of the company soaring nearly 20% the following trading day. Earnings of $1.91 per share versus estimates of $-0.24 per share were a big part of the equation. The return to profitability for Tesla was great news for Tesla longs, but short sellers were obviously less than thrilled. On Thursday, October 24^th, the earnings beat provided shorts with an overall paper loss of $1.5 billion dollars in the span of a single trading day. Tesla’s share price rose about $45 dollars, or 20%, the day after the earnings release.

Short Selling Risk

The reason that short-sellers lost such a huge amount is in part due to their historic success betting against Musk and his electric car business. Tesla has only reported profitable quarters 4 times over the previous 5 years of earnings releases. Critics of Musk often cite his erratic behavior, divided attention between multiple businesses, and recent trade pressure with China as reasons to bet against the future success of Tesla. These factors combined with historically poor earnings has led to Tesla becoming one of the most heavily shorted stocks on the market.

Short sellers are people that bet on a stock’s price to fall in the future. Their strategy speculates on the decline of a stock, but many portfolio managers and investors also use short selling as a way to hedge against the downside risk of their long positions. Going short in a security involves borrowing shares of a company to sell to people in the market with the goal of purchasing shares of the same company in the future at a lower price to cover the short. The further the price of the security declines, the more profitable the position becomes for short-sellers.

Short Selling Reward 

Short selling can be lucrative thanks to the possibilities of high profits and low initial capital investment required to open the positions. However, short-sellers are also at risk for unlimited losses and the potential for short squeezes. Tesla shorts were up around $2 billion in mark-to-market profits prior to the Q3 earnings release. Unfortunately for them, the surprise earnings beat wiped out the majority of those gains in the span of a day. It’s worth noting that Tesla Inc. is still down roughly 10% in 2019.

Even though shorts were hit hard in Q3, don’t expect the short interest in Tesla to drop off entirely after this surprising news. Tesla is still one of the most heavily shorted stocks on the market. Although Tesla reported a boost in profit with their Q3 earnings, vehicle sales still missed analyst expectations. All of the uncertainty in China also doesn’t bode well for Tesla’s future financial prospects.

Bottom Line

These types of stories remind traders that holding open speculative positions through earnings can be a very risky endeavor. The market tends to react dramatically to surprise earnings beats and misses. It always pays off to listen in on earnings calls and scan through the 10Ks of companies after earnings reports to get a better idea of what expect going forward. Knowing when to take profits and expecting the unexpected are two qualities that many of the most successful traders possess. Hopefully, Tesla short-sellers learned that valuable lesson after taking a $1.4-billion-dollar hit.