Joining a stock market index, while not affecting a company’s business, can cause some volatility. Velodyne Lidar (NASDAQ: VLDR) announced today that the company will be included in the Russell 2000 Index as part of the index operator’s annual recompilation of the market barometers it manages and licenses.
The Russell 2000 is one of the most widely used indices for small cap stocks. The change comes into effect on June 28th.
By 1:00 p.m. EDT, Velodyne stock was up 22%.
Why stocks jump on index inclusion
In general, news of prominent indexing will drive a stock’s price higher for a number of reasons. For starters, the announcement can be seen as endorsement and credibility for the company joining an index, as the addition suggests that the stock is important enough to financial markets.
More specifically, inclusion in a prominent index forces a variety of passive mutual funds that track the underlying index to buy the stocks for their portfolio. These funds are required to invest in everything contained in the index. The more prominent the index, the more pronounced the effect.
For example the iShares Russell 2000 ETF (NYSE: IWM) is a huge fund with net assets under management (AUM) of over $ 68 billion. This is just a fund that tracks the popular small-cap index.
“As the first public pure-play lidar company, our inclusion in the Russell 2000 Index is further clear evidence of our global leadership position,” said Velodyne CEO Anand Gopalan in a statement. “We are incredibly proud of what we achieve as a company by developing groundbreaking products with which our customers change markets and touch everyday life in a meaningful way.”
Trigger a short squeeze
It’s worth noting that there are other factors likely to add to the rally. Velodyne went public last summer through its merger with a special purpose vehicle (SPAC), and investor sentiment towards SPACs has deteriorated in recent months due to valuation issues, overuse of high forecasting, and regulatory scrutiny.
In addition, Velodyne was embroiled in a scandal after founder David Hall and his wife Marta Hall (who served as chief marketing officer) were ousted earlier this year after an internal investigation revealed inappropriate behavior.
David Hall, who remains the majority shareholder of Velodyne, has launched an offensive attack on the company claiming the board of directors has “promoted an anti-shareholder culture”. A few days ago, the founder repeated an appeal to chairman Brad Culkin and CEO Anand Gopalan to resign.
All of the controversy, combined with the background of SPAC pessimism, has resulted in a surge in short interest. In mid-May, bearish investors held around 24% of Velodyne’s float in hopes of a decline.
Retailers, many of whom congregate on Reddit’s WallStreetBets subreddit, have started targeting stocks with high short interest to create a short squeeze. This happens when short sellers who previously borrowed and sold the stock frantically buy back stock to close out their positions. Short squeeze can temporarily reinforce upward movements and may play a role in Velodyne’s pop.
In a way, a high short interest can be interpreted as a coiled spring. All the stock needs is a positive catalyst – like being in the index – to trigger it.
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