What Are Days to Cover?
"Days to cover" measures the expected number of days needed to close out a company's outstanding shares that have been sold short. It computes a company's shares that are currently shorted divided by the average daily trading volume to give an approximation of the time required, expressed in days, to close out those short positions.
Days to cover are related to the short ratio as a measure of short interest in a stock.
- Days to cover is a temporal indication of the short interest in a company's stock.
- It is a general indication of how much of a company's stock is shorted relative to its trading volume.
- Days to cover is calculated by taking the quantity of shares that are currently sold short and dividing that amount by the stock's average daily trading volume.
- A high days-to-cover measurement can signal a potential short squeeze.
Understanding Days to Cover
Days to cover are calculated by taking the number of currently shorted shares (known as a stock's short interest) and dividing that amount by the average daily trading volume for the company in question. For example, if investors have shorted 2 million shares of ABC and its average daily volume is 1 million shares, then the days to cover is two days.
Days to cover = current short interest ÷ average daily share volume
Days to cover can be useful to traders in the following ways:
Days to cover can be viewed as a proxy for how bearish or bullish traders are about that company, which can aid future investment decisions. A high days-to-cover ratio might be a harbinger that all is not well with company performance.
It thus gives investors an idea of potential future buying pressure. In the event of a rally in the stock, short sellers must buy back shares on the open market to close out their positions. Understandably, they will seek to purchase the shares back for the lowest price possible, and this urgency to get out of their positions could translate into sharp moves higher. The longer the buyback process takes, as referenced by the days to cover metric, the longer the price rally may continue, based solely on the need of short sellers to close their positions.
A high days-to-cover ratio can often signal a potential short squeeze. This information can benefit a trader looking to make a quick profit by buying that company's shares ahead of the anticipated event actually coming to fruition.
The Short Selling Process and Days to Cover
Traders who short sell are motivated by a belief that the price of a security will fall, and shorting the stock allows them to profit from that decline in price. In practice, short selling involves borrowing shares from a broker, selling the shares on the open market, and then buying the shares back in order to return them to the broker.
The trader benefits if the price of the shares falls after the shares are borrowed and sold, as this allows the investor to repurchase the shares at a price lower than the amount for which the shares are sold. The days to cover represent the total estimated amount of time for all short sellers active in the market with a particular security to buy back the shares that were lent to them by a brokerage firm.
If a previously lagging stock turns very bullish, the buying action of short sellers can result in extra upward momentum. The higher the days to cover, the more pronounced the effect of upward momentum may be, which could result in larger losses for short sellers not among the first to close their positions.
What Does Days to Cover Tell You?
Days to cover is a metric that estimates how long it would take all short sellers to close out their open positions if those short sellers were to buy the stock on the open market. A large value for days to cover indicates a short squeeze in that the stock may be in an uptrend and that supply may not be able to keep up with the demand of buyers, and may indicate a potential short squeeze.
What Is a Short Squeeze?
A short squeeze is a cascading rally in the price of a stock that is caused by investors rushing to cover short positions. If the short interest is high, the increased buying pressure can lead to a sharp rise in the price of the stock.
How Do You Estimate the Amount of a Company's Shares That Are Sold Short?
You can tell how many shares of a company's stock are outstanding by looking at its short interest. Short interest represents the total amount of shares sold by short sellers in a particular stock. The number of days covered by short sellers is the difference between the days-to-cover measurement and the number of days the stock has been on the market. Based on this information, you can approximate the number of short sellers in a stock, which helps provide some context for whether the current level of days to cover is high or not, relative to recent history.
What Is the Difference Between Days to Cover and Short Interest?
Days to cover is a measure of how many days it would take for all outstanding shorted shares to be closed out at the current rate of open-market buying. Short interest is the total shares sold short in a stock, and it can vary from one reporting period to the next.
What Does a High Short Interest Ratio Mean?
A high short interest ratio means that relatively more shares of a stock have been sold short than long, which means that bearish investors are playing a bigger role in the trading of that particular stock. When short interest is high on a particular stock, it can signal a potential short squeeze because if the stock rises sharply, many short sellers may be forced to cover their positions—so traders should keep an eye on a stock with a high short-to-long ratio.
The Bottom Line
Days to cover is a metric used by traders to estimate how long it might take all short sellers to close out their open positions if those short sellers were to buy the stock on the open market. A high days-to-cover value can indicate that short sellers could be subject to a short squeeze and have to close out their positions at higher prices, because a stock may be in an uptrend and supply may not be able to keep up with the demand of buyers. Days to cover is calculated as a stock's current short interest divided by its average daily trading volume.