Going Long the Short List

On Wall Street, the technical term for this is "failure to deliver" the shares. That's because every time a broker lends out shares to a short-seller, the broker also must be able to either borrow the shares from another firm, or produce the shares when the trade is supposed to settle three days later.

Before Regulation SHO, failure-to-deliver scenarios were frequently one of the factors that led to the spread of naked shorting, either by design or neglect. But the new rule rectifies this situation by forcing brokers to close out trades where there are no shares available to settle a trade.

Mary Ann C. Bartels, a Merrill Lynch trading strategist, agrees that the threshold lists could present some interesting opportunities for nimble traders. In a recent research notes, she says "threshold securities are likely to experience higher-than-usual price volatility due to a higher probability for a short squeeze." In addition, Bartels says some traders may become "more cautious" about trading until more is known about Regulation's SHO's impact on the market.

Bartels' own list of potential threshold stocks includes online travel publisher Travelzoo(TZOO), electronic toy manufacturer LeapFrog(LF) and broadband company Charter Communications(CHTR).

The inclusion of a stock on a threshold list is no guarantee that the stage is set for a short squeeze rally.

The hedge fund trader says an investor has to consider a variety of factors, such as the impact of earnings, the potential issuance of new shares by the company and the size of any gains posted by the stocks in 2004. He says many of the stocks likely to be classified as threshold securities are ones that "have had a good run already" and are poised for a selloff.

Still, Regulation SHO and the threshold list give traders a whole lot more to think about before investing or shorting a small-cap stock.

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