Betting on the Likelihood of a Short Squeeze

Abstract

Short squeezes often lead to large increases in stock prices. Using a novel measure of the likelihood of short squeezes we show that it explains lottery or skewness-seeking-investing. As in other instances of securities with right-skewed returns documented in the literature, these investors buy call options instead of the underlying stocks, to maximize the right-skewness of their investment. In particular, they are willing to pay a premium for the upside potential. This type of investment strategy has attracted much attention recently, but we document that it has been used for decades.