Massive Short Squeeze In Volkswagen (VLKAY) Triggers Government Regulator Inquiry

The German financial-market regulator is going to look into trading of Volkswagen AG (OTCBB: VLKAY) shares after Porsche SE's announced its plans to increase its stake in the automaker triggered a fourfold increase in 48 hours.

After Porsche announced on October 26th that it plans increasing its stake in Volkswagen from 42.6% to 75%, short-sellers had to cover their bets of a drop in the stock, which in turned resulted in Volkswagon's stock skyrocketing. The short squeeze in Volkswagen, pushed Volkswagen's valuation as high as $370 billion, above the market cap of Exxon Mobil (NYSE: XOM).

Volkswagen is the most shorted stock in Germany's benchmark DAX Index with about 12.9% of Volkswagen's stock on loan, mostly for short sales.

There was speculation in the market that large investment banks, Morgan Stanley (NYSE: MS) and Goldman Sachs (NYSE: GS) both suffered substantial losses from the unwinding of the Volkswagen short trade. Later, sources at both Goldman and Morgan Stanley both denied having significant losses related to Volkswagen.

HSBC analyst, Horst Schneider, wrote in a note, "Porsche heads for a domination agreement and triggers a short-squeeze. Volkswagen will be more driven by covering of short positions rather than by fundamental valuations.''

Some speculate the jump was caused by their being little ordinary stock available for trading because most of the Volkswagen shares are owned by Porsche, the German state of Lower Saxony and the banks that underwrote Porsche's options. Lower Saxony is Volkswagen's second-largest owner with a 20.1% interest. Additionally, index-tracking funds also hold stakes in Volkswagen, now the DAX's most heavily weighted stock, and must retain the holdings as long as Volkswagen remains a member.

Short sales have largely been undertaken by investors betting on a decline in Volkswagen's common stock, which hold voting rights, or its underperformance relative to the preferred shares, which carry no votes, according to analysts.

Bloomberg reported that GLG Partners Emmanuel Roman told a conference in London, "Volkswagen has been one of the greatest shorts of hedge funds, and it's been an absolute, absolute disaster. It's been very painful.''

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