June 24, 2011 | In: General

Days to Cover Calculation

The days to cover, also referred to as short interest ratio, is the number of days that it takes for all short shares to be covered (e.g. bought back by the investor to return them to the borrower), based on the daily average trading volume of the stock. Days to cover is an important metric to see if the stock is vulnerable to a short squeeze.

Here’s the formula to calculate the number of days to cover:

DTC = TNSS / DAV (where DTC = days to cover, TNSS = Total Number of Shares Short, DAV = Daily Average Volume)

Let’s look at YOKU, a dangerous stock. YOKU has an average volume of 3.6 million shares/day and has 9.04 million shares that are short. According to the formula above:

Days to Cover = 9.04 / 3.6 = 2.51

This means that it will take all investors who have shorted the stock 2.51 days to buy back the YOKU shares that they borrowed, provided that all the trading in the stock consists of shorters covering.

Why is the number of days to cover important?

The number of days to cover is indicative of the potential of a short squeeze, the higher the number of days to cover, the higher the possibility of a short squeeze (they are proportional to each other). In the case of YOKU, the situation is not that horrible. But imagine a stock with short interest ratio of 40 (i.e. number of days to cover is 40), in case the stock goes up and shorters decide to start covering, then it’ll take 40 days to reduce that short interest ratio to 0, and since the stock has already a normal daily volume of its own, the volume will be double for these 40 days. So, for 40 days, you will have a lot of buying at double the volume, which will make the stock soar (the stock can go up 100% easily in this case meaning a lot of loss for shorters).

In short, avoid to short stocks that have a high interest ratio, or risk the chance of being burned if the stock suddenly reverses the trend.

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