A critical mistake cost traders betting against Snap huge profits (SNAP)

Evan Spiegel

Snap turned in a disastrous third-quarter earnings report on Tuesday that saw its stock plummet as much as 22% in after-hours trading.
Short sellers pared positions in the weeks leading up to earnings, costing themselves potentially huge profits that would've resulted from the stock drop.
Even Tencent's acquisition of a 10% stake in Snap couldn't rescue the company's shares, which were still down about 11% in early trading on Wednesday.

Snap may be the most shorted app-based company in the world, but traders betting on a decline in the stock took their foot off the gas at exactly the wrong time.

They covered $115 million of their positions in the week leading up to Snap's disastrous earnings report on Tuesday and trimmed $278 million from a year-to-date high reached in mid-October, according to data compiled by the financial analytics firm S3 Partners.

As Snap's stock plummeted as much as 22% in after-hours trading after reporting smaller-than-expected user growth and a huge drop in advertising rates, those short sellers who exited their positions missed out on a potential windfall.

While Snap bears reaped at least some healthy profits from the decline — after all, S3 Partners says $1.7 billion of the company's shares are still held short — many will lament the missed opportunity.

Their short covering was nearly rewarded in early-morning trading as CNBC reported that the Chinese investment-holding company Tencent took a 10% stake in Snap. The news temporarily erased most of the loss, before more sellers stepped in and pushed shares back down. Snap was down about 11% in early trading on Wednesday.

The fact that short sellers pared their positions heading into earnings is surprising, considering the options market had signaled an 18% implied share move the day before, according to Bloomberg data.

While it's possible that traders figured Snap's already damaged stock couldn't fall much further — or perhaps they were just outwardly bullish on the company's earnings prospects — it's still surprising that they went so far to dent profits from a huge share drop.

Snap's stock is down 20% since its initial public offering at $17 in March — and with the way things are going, short sellers might think twice before throwing in the towel on positions in the future.

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