This stock is setting up for 'short squeeze': Trader

Some savvy traders are shopping for Abercrombie and Fitch shares.

Despite being down 24 percent year to date, the stock is surging this week, up more than 5 percent since Monday. And some options traders are betting on an even bigger rally to come in the next several weeks.

On Tuesday, when options call volume ran more than two times its volume, traders bet that Abercrombie shares could rise more than 15 percent by mid-July. Specifically, the traders bought the July 25-strike calls for 16 cents each. Since buying a call option allows a trader to purchase a stock at a given price for a set time, this trade is profitable if Abercrombie shares rise above $25.16 by July expiration.

"I think this could be a potential short squeeze," CNBC Contributor Mike Khouw said Tuesday on CNBC's "Fast Money." And Khouw's reasoning is based on three key factors. "The stock has 34 percent short interest, that's the highest in the specialty apparel retailers in the Russell 3000." In addition to massive short interest, Khouw pointed out that Abercrombie is the second-worst rated stock in that group. Out of the 34 analysts that cover the stock, the average rating is a "hold" with a price target of $21.26, according to FactSet. And lastly, said Khouw, "It's the third-cheapest in the group." Abercrombie shares have lost nearly 45 percent of its value in the past 12 months.

"This trade is setting up for a short-term rally of almost 20 percent in the next 45 days," Khouw said.

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