Chanos & Co. plans to short digital REITs – how will they do it?
Famed short seller Jim Chanos, now running Chanos & Company (the rebranded Kynikos Associates), said in the Financial Times that the firm was raising a fund to short REITs that focus on digital data centers: “‘This is our big short right now. The story is that although the cloud is growing, the cloud is their enemy, not their business. Value is accruing to the cloud companies, not the bricks-and-mortar legacy data centres.’ Data centres owned by groups such as Digital Realty Trust and Equinix are vast warehouses of servers that power large swathes of the internet.” The big competitors-to-be include Microsoft, Amazon and Google.
We looked into Digital Realty Trust (NYSE: DLR) to see if short side pressure was on the rise and where it was showing up. The securities lending market was easy to rule out. According to market sources, the current rebate rate is around 1.48% while the Fed’s benchmark Overnight Bank Funding Rate is at 1.57%. With a 9 bps spread, this puts DLR firmly in General Collateral territory. Likewise, securities lending volumes are low, under 7,000 shares, about $818,000 in value compared to a market cap of $37 billion. Chanos could be getting supply from prime broker internalization pools, but any other investor looking to follow him into bear territory on DLR would do well to lock up a term securities loan from an agent lender at this point.
In total return swaps, volumes are much, much higher. We can’t say yet from the available data what’s long and what’s short, but we can say that if you started at 0 float in January 2022, that would have increased to $175.5 million by the end of June 2022, with $263.4 million in new trades reported and $87 million in terminations and expirations. The TRS market is more active than the physical short selling market at a proportion that is much greater than what prime brokers said their revenues were coming from for all synthetic and physical transactions a couple of years ago. Most trades were for two months or less, but we noted a set of transactions conducted in May 2022 all on the same day with expiration dates in April 2027. Someone was planning to be in for a longer haul.
Lastly we turn to the options market where put open interest outweighs call open interest, 37,678 to 12,983. Expressed another way, the percentage of put open interest is 74% of all open interest while calls are 26%. While we are hesitant to ascribe a specific economic value to each put and call based on buys and sells, it is safe to say that there is more of an expectation that DLR’s stock price is going down than up. To place the DLR interest in perspective, the put open interest for SPY is 10,479,272 while the call open interest is 6,955,802, a 60/40 ratio in favor of puts.
Between securities lending, options and TRS, we find that TRS has the market share for DLR. We’ve heard for years that hedge funds and prime brokers are preferring TRS over physical shorts due to better balance sheet treatment and market opacity. The data prove this out.
Having organized the data, this analysis took under one hour to complete manually. What will happen when algorithms get to work and start crunching the numbers intraday?