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Mind the Short Covering Rally: Five Stocks That May Pop

Roberto Pedone | TheStreet.com Contributor
Wednesday, 6 Mar 2013 | 3:37 PM ET
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Short-sellers hate being caught short a stock that reports a blowout quarter. When this happens, we often see a short squeeze develop as the bears rush to cover their positions to avoid big losses. Even the best short-sellers know that it's never a great idea to stay short once a bullish earnings report sparks a big short-covering rally.

This is why I scan the market for heavily shorted stocks that are about to report earnings. You only need to find a few of these stocks in a year to help enhance your portfolio returns—the gains become so out sized in such a short time frame that your profits add up quickly.

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That said, let's not forget that stocks are heavily shorted for a reason, so you have to use trading discipline and sound money management when playing earnings short-squeeze candidates.

It's important that you don't go betting the farm on these plays, and that you manage your risk accordingly. Sometimes the best play is to wait for the stock to break out following the report before you jump in to profit off a short squeeze. This way, you're letting the trend emerge after the market has digested all of the news.

Of course, sometimes the stock is going to be in such high demand that you risk missing a lot of the move by waiting. That's why it can be worth betting prior to the report—but only if the stock is acting technically very bullish, and you have a very strong conviction that it is going to rip higher.

Just remember: even when you have that conviction and have done your due diligence, the stock can still get hammered if Wall Street doesn't like the numbers or guidance.

If you do decide to bet ahead of a quarter, then you might want to use options to limit your capital exposure. Heavily shorted stocks are usually the names that make the biggest post-earnings moves and have the most volatility. I personally prefer to wait until all the earnings-related news is out for a heavily shorted stock and then jump in and trade the prevailing trend.

With that in mind, here's a look at several stocks that could experience big short squeezes when they report earnings this week.

Ciena

My first earnings short-squeeze trade is communications equipment player Ciena, which is set to release numbers on Thursday before the market open. Wall Street analysts, on average, expect Ciena to report revenue of $449.21 million on a loss of 13 cents per share.

Just this morning, Citigroup optical networking technology analyst Kevin Dennean wrote in a letter to clients that an inflection point is approaching for the field, which could give a lift to shares of Ciena in particular.

The current short interest as a percentage of the float for Ciena is very high at 18.7 percent. That means that out of the 85.45 million shares in the tradable float, 18.33 million shares are sold short by the bears.

The bears have also been increasing their bets from the last reporting period by 6.1 percent, or by about 1.05 million shares. If the bears are caught pressing their bets too strong into a bullish quarter, then shares of Ciena could explode higher post-earnings.

From a technical perspective,the stock is currently trending above its 200-day moving average and just below its 50-day moving average, which is neutral trendwise. This stock has been trading in consolidation pattern for the last three months, with shares moving between $14.37 on the downside and $16.72 on the upside. A high-volume move above the upper-end of that range could spark a breakout trade for Ciena's stock post-earnings.

If you're bullish on Ciena, then I would wait until after its report and look for long-biased trades if this stock manages to break out above its 50-day moving average of $15.58 a share and then once it takes out more resistance at $16.59 to $16.72 a share with high volume.

Look for volume on that move that hits near or above its three-month average action of 3.49 million shares. If that breakout triggers, then the stock will set up to re-test or possibly take out its next major overhead resistance levels at $17.85 to $18.39 a share.

I would simply avoid Ciena or look for short-biased trades if after earnings it fails to trigger that breakout, and then drops back below some key near-term support levels at its 200-day moving average of $14.82 a share and then below more support at $14.53 to $14.37 a share with high volume. If we get that move, then CIEN will set up to re-test or possibly take out its next major support levels at $13.52 to $12.50 a share.

Skullcandy

Another potential earnings short-squeeze play is headphones and other audio accessories developer and distributor Skullcandy, which is set to release its numbers on Thursday after the market close. Wall Street analysts, on average, expect Skullcandy to report revenue of $98.61 million on earnings of 48 cents per share.

If you're looking for a heavily shorted stock that's been destroyed by the bears heading into its earnings report, then make sure to take a hard look at shares of Skullcandy. This stock has been crushed by the sellers during the last six months, with shares down by 59 percetn. That move has shares of Skullcandy currently trading just 20 cents off its 52-week low of $5.98 a share.

The current short interest as a percentage of the float for Skullcandy is extremely high at 26 percent. That means that out of the 15.68 million shares in the tradable float, 4.40 million shares are sold short by the bears. If this company can deliver the earnings news the bulls are looking for, then we could easily see a monster short squeeze develop post-earnings.

From a technical perspective, Skullcandy is currently trending below both its 50-day and 200-day moving averages, which is bearish. This stock has been downtrending badly for the last six months, with shares falling from its high of $14.58 to its recent low of $5.98 a share. During that downtrend, shares of Skullcandy have been consistently making lower highs and lower lows, which is bearish technical price action. That said, the stock has recently formed a double bottom at $6 a share and its trending within range of triggering a near-term breakout trade.

If you're in the bull camp on Skullcandy, then I would wait until after its report and look for long-biased trades if this stock manages to break out above its 50-day moving average of $6.83 a share and then once it takes out more overhead resistance at $6.94 to $7.09 with high volume. Look for volume on that move that registers near or above its three-month average action of 688,837 shares. If that breakout hits, then Skullcandy will set up to re-test or possibly take out its next major overhead resistance levels at $7.40 to $8 a share. Any high-volume move above $8 will then put its next major overhead resistance levels at $8.75 to $9 into range for shares of Skullcandy.

I would simply avoid Skullcandy or look for short-biased trades if after earnings it fails to trigger that breakout, and then drops back below some key near-term support levels at $6.01 to $5.98 a share with high volume. If we get that move, then SKUL will set up to enter new 52-week- and all-time-low territory below $5.98 a share, which is bearish price action. Some possible downside targets off that move are $5 to $4 a share.

Sarepta Therapeutics

Another earnings short-squeeze prospect is biotechnology and drugs player Sarepta Therapeutics, which is set to release numbers on Thursday before the market open. Wall Street analysts, on average, expect Sarepta Therapeutics to report revenue of $6.71 million on a loss of 29 cents per share.

Just this morning, Leerink Swann initiated coverage of Sarepta Therapeutics with an outperform rating and a $45 price target on the stock.

The current short interest as a percentage of the float for Sarepta Therapeutics is pretty high at 15.6 percent. That means that out of the 23.06 million shares in the tradable float, 4.12 million shares are sold short by the bears. The bears have also been increasing their bets from the last reporting period by 7.5 percent, or by about 287,000 shares. If the bears are caught leaning too hard into a bullish quarter, then shares of Sarepta Therapeutics could explode higher post-earnings.

From a technical perspective, SRPT is currently trending above both its 50-day and 200-day moving averages, which is bullish. This stock has been uptrending for the last month, with shares moving higher from its low of $25.80 to its recent high of $32.40 a share. During that uptrend, shares of SRPT have been mostly making higher lows and higher highs, which is bullish technical price action. That move has started to push shares of SRPT within range of triggering a major breakout trade.

If you're bullish on Sarepta, then I would wait until after its report and look for long-biased trades if this stock manages to break out above some near-term overhead resistance at $32.40 a share with high volume. Look for volume on that move that hits near or above its three-month average action of 1.31 million shares. If that breakout triggers, then the stock will set up to re-test or possibly take out its next major overhead resistance levels at $35 to $40 or even $45 a share.

I would avoid Sarepta or look for short-biased trades if after earnings it fails to trigger that breakout, and then drops back below some key near-term support levels at $28.35 to its 50-day at $26.96 a share with high volume. If we get that move, then Sarepta's shares will set up to re-test or possibly take out its next major support levels at $25.80 to $23.46 a share.

Vail Resorts

Another earnings short-squeeze candidate is mountain resort operator Vail Resorts, which is set to release numbers on Wednesday after the market close. Wall Street analysts, on average, expect Vail Resorts to report revenue of $414.13 million on earnings of $1.70 per share.

The current short interest as a percentage of the float for Vail Resorts is notable at 7.5 percent. That means that out of the 35.39 million shares in the tradable float, 2.67 million shares are sold short by the bears. The bears have also been increasing their bets from the last reporting period by 3.5 percent, or by about 90,000 shares. If the shorts are caught being too aggressive into a strong quarter, then shares of MTN could rip higher post-earnings.

From a technical perspective, Vail Resorts is currently trending above both its 50-day and 200-day moving averages, which is bullish. This stock has been uptrending strong for the last month, with shares moving higher from its low of $50.74 to its intraday high of $56.75 a share. During that uptrend, shares of Vail Resorts have been consistently making higher lows and higher highs, which is bullish technical price action. That move has now pushed shares of Vail Resorts within range of triggering a near-term breakout trade post-earnings.

If you're bullish on Vail Resorts, then I would wait until after its report and look for long-biased trades if this stock manages to break out above some near-term overhead resistance at $56.89 a share and then once it takes out more resistance at $58.19 to $59.09 a share with high volume. Look for volume on that move that registers near or above its three-month average action of 247,988 shares. If that breakout triggers, then the stock will set up to enter new 52-week high territory above $59.49 a share, which is bullish technical price action. Some possible upside targets off that breakout are $65 to $67 a share.

I would avoid Vail Resorts or look for short-biased trades if after earnings it fails to trigger that breakout, and then drops back below its 50-day moving average at $54.23 a share with high volume. If we get that move, then the stock will set up to re-test or possibly take out its next major support levels at its 200-day of $52.17 or at $50.74 to $49.18 a share.

Thor Industries

My final earnings short-squeeze play today is manufacturer and seller of recreation vehicles and small to mid-sized buses Thor Industries, which is set to release numbers on Thursday after the market close. Wall Street analysts, on average, expect Thor Industries to report revenue of $715.73 million on earnings of 38 cents per share.

If you're looking for a stock with a decent short interest that's been uptrending strong heading into its earnings report this week, then make sure to check out shares of Thor Industries. This stock has been in play with the bulls for the last six months, with shares up 21 percent.

The current short interest as a percentage of the float for Thor Industries stands at 10.6 percent. That means that out of the 50.09 million shares in the tradable float, 4.74 million shares are sold short by the bears. If this company can give the bulls the earnings news they're looking for, then this stock could see a sharp short-covering rally post-earnings.

From a technical perspective, Thor Industries is currently trending above its 200-day moving average and just below its 50-day moving average, which is neutral trendwise. This stock has been trending sideways for the last month, with shares moving between $36.30 on the downside and $38.60 on the upside. A high-volume move above the upper-end of that range could trigger a major breakout trade for shares of Thor Industries post-earnings.

If you're in the bull camp on Thor Industries, then I would wait until after its report and look for long-biased trades if this stock manages to break out above its 50-day moving average of $39.16 a share with high volume. Look for volume on that move that hits near or above its three-month average volume of 720,585 shares. If that breakout triggers, then THO will set up to re-test or possibly take out its next major overhead resistance levels at $41 to $42 a share. Any high-volume move above $42 will then put $43 to $44.28 into range for shares of Thor Industries.

I would simply avoid Thor Industries or look for short-biased trades if after earnings it fails to trigger that breakout, and then drops back below some key near-term support at $36.30 a share with high volume. If we get that move, then THO will set up to re-test or possibly take out its next major support levels at $34.16 to its 200-day at $33.72 a share.

By TheStreet.com Contributor Roberto Pedone

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Disclosures:

At the time of publication, author had no positions in stocks mentioned.

TheStreet does not permit any employees on its editorial staff to individually hold positions in individual stocks, though they are permitted to own stock in TheStreet.

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Disclaimer

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CIEN
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SKULLCANDY
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SRPT
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MTN
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THO
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