DGAZF Short Sellers Lose $2B On Black Swan Blowout

Investing always carries a certain degree of risk, but short selling can be particularly risky given potential losses are limitless.

Most of the time, extreme short-term losses are purely theoretical, but short sellers of the VelocityShares Daily 3x Inverse Natural Gas ETN DGAZF recently experienced a black swan pricing blowout that served as a costly $2 billion lesson about the dangers of short selling.

In early August, the leveraged inverse natural gas ETN traded at around the $400 level, but in a matter of days the fund had skyrocketed as high as $24,000.

See Also: DGAZF Disaster Strikes As Dying ETN Blows Out Past Real Net Asset Value

The DGAZF ETN was one of several ETNs delisted by Credit Suisse earlier this summer, but the fund continued to trade on the OTC market. In early August, the DGAZF fund began trading at a massive premium to its net asset value. One the fund started spiking, momentum traders and short-covering volume created a massive spike in demand.

As a result of the crazy trading action, the SEC halted the DGAZF fund and Credit Suisse issued a press release explaining that it's bumping up the maturation date for the fund to August 25.

Short Sellers Trapped: S3 Partners analyst Ihor Dusaniwsky said Friday that DGAZF short sellers took a $2 billion loss in less than a week when the share price skyrocketed from $720 to $15,000. In fact, short sellers endured a $1.68 billion mark-to-market loss in a single day on Aug. 12 alone.

Looking ahead, Dusaniwsky said short sellers will likely continue to scramble to cover their positions by the new Aug. 25 maturation date given there are still roughly 140,000 shares of the fund held short. At this point, however, he said it’s unlikely the remaining short sellers will be able to find enough sellers to avoid catastrophic losses.

“It is unlikely short sellers exit their trades unscathed, as it is unlikely DGAZF’s price falls back to ‘normal’ levels by August 25th,” Dusaniwsky said.

Benzinga’s Take: The situation with the DGAZF ETN is a cocktail of red flags for investors about just how dangerous the stock market can be if you don’t fully understand or manage the risks in your trades. Short selling, leverage and lack of liquidity all ramp up the potential for huge short-term swings in share price that are much more a function of market dynamics than anything having to do with the underlying price of natural gas or the fundamental NAV of the fund.