Squeeze Out Profits With Options
Short selling stock is a popular investment technique that investors can use to generate profits from stocks ready to drop, making money as shares lose value. But when traders bet wrong, their investments can have the opposite affect from their original intention and actually cause the targeted stock to see a big jump in share value –a so-called “short squeeze” that other investors can take advantage of.
Here’s how it works: Someone shorting a stock borrows it from his broker and sells it with plans to buy it back for less and pocket the difference. But if the stock rises the short seller must go into the market and buy it back. A “short squeeze” occurs when a number of traders have shorted a stock and rush to buy it, causing the stock price to jump upward.
Call options can be used to inexpensively leverage these quick moves. The trick is to uncover the stock before it jumps. In our Winning Edge service we find stocks that are performing well and have a high level of short interest.
We selected stocks this week from a short-interest filter that looks at up trending stocks with more than 20% of their float (the number of publicly-owned shares) tied up in short interest. Our list includes Netflix (NASDAQ: NFLX), Liz Claiborne (NYSE: LIZ), GameStop (NYSE: GME) and three more.
Netflix (NASDAQ: NFLX)
This is the Rodney Dangerfield of stocks — it can’t get any respect. Despite hitting yet another all-time high this week and gaining more than 380% since the beginning of 2010, the shorts continue to bet against NFLX.
Analysts are also skeptical, with just 12 of 29 recommending the stock as a “buy.”
Why? Frankly, we don’t care. Let the doubters say what they want. Netflix is a classic “climb the wall of worry” stock. The higher it gets, it seems more are willing to call a top. That tells us that the current rally has plenty of strength to run higher.
Buy the NFLX July 280 Call for under nine bucks.
Liz Claiborne (NYSE: LIZ)
With more than a third of the float tied up in short interest and just one of six covering analysts having the smarts to consider the stock a “buy,” LIZ is clearly “under loved.” Obviously it must be doing horribly, right?
Well, not exactly. In fact, the shares are up more than 40% off their January low, trading consistently higher along the support of their 20-day moving average. And there’s plenty of room to grow (about 20%) before the stock hits its December high.
With a strong uptrend intact and plenty of pessimism available to unwind into buying pressure, look for LIZ to continue its run higher. Buy the LIZ July 6 Call for around 85 cents.
CIENA (NASDAQ: CIEN)
This networking company has nearly a third of its float tied up in short interest. That represents a lot of pent-up buying power that could help the shares power to a multi-year high.
Currently, CIEN shares are bouncing higher off their 100-day moving average, a trend line that provided solid support in March and October and November of last year. Each of those reversals led to strong rallies that covered at least 30%.
Now the stock appears poised for another repeat performance. And with earnings coming up next week (June 8), the stock could easily challenge its 2011 high above the 29 level.
Buy the CIEN July 26 Call for around two bucks.
GameStop (NYSE: GME)
The largest video game retailer in the world is powering higher despite issuing an earnings forecast that fell below Wall Street estimates a couple of weeks ago. In fact, GME rallied off its 20-day moving average to hit its highest point in more than two years.
But that hasn’t stopped short sellers from shorting about 30% of the stock’s float. And with the stock selling for less than half its all-time high reached in late 2008, there’s plenty of room for the shares to grow. What’s more, the stock is relatively cheap with a forward P/E of less than 9.0.
GME is up 44% from its mid-March low. With plenty of short-interest fuel available, look for a run to the 2009 high around 33, a move of around 17%.
Buy the GME July 27 Call for around $1.90.
Western Refining (NYSE: WNR)
As you might guess, WNR is an independent crude oil refiner with a presence primarily in the Southwest and Mid-Atlantic. The weird thing about WNR is that it’s missed its last four earnings estimates, usually by a wide margin. Yet the stock has more than tripled in price over the past year.
Currently the shares in the midst of a week-long 8% rally coming off the solid support of their 100-day moving average. This trend line supported the stock three times in May, allowing just one daily close below it. The current rally has pushed the stock past its key 50-day moving average, leaving the 2011 high at 19.50 as the next target. That’s a move of 12%.
With a third of the float sold short and just half the covering analysts rating the stock a “buy,” pessimism toward WNR appears out of synch for a stock that is up more than 60% for the year. That tells us this rally has legs. Buy the WNR July 17 Call for around $1.60.
Star Scientific (NASDAQ: CIGX)
This company develops dissolvable smokeless tobacco products that limit the intake of carcinogens. According to Yahoo! Finance, CIGX has just 31 full-time employees, which is pretty good for a company with a market cap of nearly $700 million that trades three to five million shares per day.
While no analysts cover the stock, the shorts have taken a keen interest, as 20% of the float is shorted. The stock is also heavily traded in the option pits, with put buyers predominating of late. Obviously there are a lot of doubters even though the equity has gained 70% in just the past six weeks.
Make no mistake; this is a very volatile stock with high-priced options. That makes this a risky play, but one that could yield a big payoff given the high level of pessimism waiting to be unleashed into buying pressure. Buy the CIGX June 5 Call for around 60 cents.
