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Short Sellers Propel Home Builder Stocks

Shares of home builders soared on Monday as a frenzy of short sellers bought stock to cover their positions, giving the overall housing stock index its greatest one-day gain in about five years.

The Dow Jones U.S. Home Construction Index, a yardstick that measures home builder performance, rose 8.1 percent in mid-afternoon trading.

"When you see this kind of move it's because the stocks are over-shorted," said Alex Barron, Agency Trading Group analyst.

Investors who short stock bet that the price of the shares will fall. They borrow the shares on the hopes that they'll replace them with shares they'll purchase at a lower price.

"As soon as the stocks start to go in the opposite direction people rush to cover their gain," Barron said.

Shares of some of the most badly beaten stocks saw hefty gains on Monday.

Among the biggest gainers were Beazer Homes, Standard Pacific, Meritage Homes and Hovnanian Enterprises.

"A lot of people have made a lot of money by shorting these names and they want to protect their gain. They rush out to buy to cover their short, but then that in turn causes the stock to move up higher, and that creates a frenzy," Barron said.

Meritage Homes, Hovnanian and Beazer are all on the New York Stock Exchange's threshold securities list. That means short sellers have had trouble finding enough of the stock to borrow over the last few weeks. That makes those stocks particularly vulnerable to short covering.

The momentum also has led some investors to think that the stocks have reached a bottom, experts said.

"What we are seeing today is classic value investing combined with short covering which many times can signal market bottoms," said Tim Biggam, lead options strategist at online brokerage thinkorswim in Chicago.

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  • Diana Olick serves as CNBC's real estate correspondent as well as the editor of the Realty Check section on CNBC.com.

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