The good news is Roku Inc (NASDAQ:ROKU) shares have rallied 178% since the end of October, rewarding the company’s early believers. The bad news is, rather than retreat, the bears have essentially doubled down on their bets against ROKU stock, more convinced than ever that the ROKU stock price is going to fall sharply before rising again.
The evidence of this manifested doubt lies in the growing degree of short interest in Roku, or the amount of shares that have been sold by people who don’t actually own the stock. They’re betting it’s going to move lower, and they intend to buy it back at a lower price and pocket the difference between the two prices.
Short selling isn’t unusual in and of itself. What’s unusual here, though, is the degree to which the market has bet against Roku stock. It’s essentially become an “all in” bet, and while it’s going to end well for one group, the traders on the other side of the table are apt to end up in tears.
Problem is, it’s still not clear which group is on the right side of the table.
The Roku Bears Have Dangerously Doubled Down
A quick explanation for those not familiar with it. Short selling is a trade in which unowned stock is sold first, with the aim of buying it at a later date at (hopefully) a lower price — a reversal of the “buy low, sell high” sequence.
Yes, it’s perfectly legal, though also infinitely risky. Whereas the maximum risk one can face by owning a stock is the amount invested in that particular trade, the theoretical risk to a short trade is infinite; there’s no actual limit on how high a stock can move. That’s why short selling, as fruitful as it can be, isn’t a terribly common practice.
The market has been anything but shy about selling ROKU stock short, however. As of the most recent tally taken in late November, 7.7 million shares of the 17.4 million in the float are currently held as a short position. That’s short interest of around 44%.
For perspective, the short interest on train-wreck stock Snap Inc (NYSE:SNAP) is only 30%, while less than 1% of the Facebook, Inc. (NASDAQ:FB) float is tied up in a short trade.
In other words, traders have collectively made a huge bet against Roku, and rather than scale out of those losing trades as the stock rose between early November and now, those bears have essentially put more money into their bearish bets.
Exacerbating the issue, of course, are headlines that only goad the bulls and the bears into a deeper conviction.
Case in point: Earlier this month, e-commerce giant Amazon.com, Inc. (NASDAQ:AMZN) began to sell the Apple TV device from Apple Inc. (NASDAQ:AAPL) and the Google Chromecast device from Alphabet Inc (NASDAQ:GOOGL, NASDAQ:GOOG).
Both products were removed from Amazon.com’s shopping site, as Amazon makes a competing line of products. Of course, all of these devices compete with the Roku, and if they’re available via the popular e-commerce website, it’s all too easy for consumers to choose a streaming player other than the Roku.
And yet, the company’s fans and followers take solace in Needham analyst Laura Martin’s assessment that the reintroduction of competing devices at Amazon.com isn’t actually a problem for Roku.
Her non-bearish assessment is a microcosm of the extreme opinions that have been voiced on the matter, and the extreme trades that have been placed on the perceived future of Roku’s stock.
Only Two Plausible Outcomes
Problem is, sooner or later, all of those short trades will be undone. It’s just a question of at what price, how and when. Either way, the outcome is going to be an extreme one augmented by the stunningly high degree of short interest.
On the one hand, if the stock edges any higher from here, the pain threshold for all of these short sellers may be surpassed. They’ll have to bail out of their trades — by buying the stock — further fanning the bullish flames that are already burning brightly.
That’s an outcome called a short squeeze, and short squeezes can drive a rally a heck of a lot faster than a conventional “this company is a must-have” mindset can.
At the other end of the spectrum is a meltdown of ROKU stock that ultimately vindicates the short sellers. In some cases, even though all of these short sellers are buying the stock to exit their trade, the selling effort is so dramatic that all the short-trade covering can’t halt the overwhelming selling effort driving the stock lower.
And with nearly half the float held as a short trade, all investors should be wondering if that crowd knows something alarming about Roku that you don’t.
Realistically speaking, there is no gentle, “in between” outcome in the cards. This battleground stock is poised to dish out only one of two wild outcomes.
Bottom Line for ROKU Stock
Which outcome will happen is likely impossible to say now, nor is it possible to say when the matter will come to its inevitable head. That’s why the smart-money move here may be scaling out of your trade before that war begins.
Once things start to unravel for better or worse, the move is likely to be fast and furious. This really is a situation where convictions are unusually and dangerously high, setting the stage for lot of volatility.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities. You can follow him on Twitter at @jbrumley.
