What Are Days to Cover?
"Days to cover" measures the expected number of days 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.
- 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 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:
- It can be 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 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.
- Additionally, 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 fall 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.
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 who are not among the first to close their positions.