Short Selling Has Beaten Down These Stocks
Short selling provides a counterbalance to the integrity of the stock market, but sometimes, when the selling is too extreme, it also works to provide an anchor for the long side to help drive up stocks.
As a trader, it is a lot easier to turn a good trade from the long end than short end, especially as the stock market bias becomes bullish.
In the previous visit, I discussed the bearish situation with heavily shorted Valeant Pharmaceuticals (NYSE:VRX) after a short was placed on the stock by well-known short seller Andrew Left of Citron Research, who made a nice gain.
Yet at the same time, Valeant could easily surge if the company can convince investors they have it wrong. If this happens, the short sellers will be rushing for the exits, pushing up the share price.
Heavily shorted stocks are worth a look for traders due to the upside potential if the stock market has it wrong on the company.
Five Heavily Shorted Stocks
Look at the trading action of massively shorted copper and oil play Freeport-McMoran Copper & Gold Inc (NYSE:FCX). The heavily indebted materials stock surged from $3.52 on January 20 to $10.50 on March 4, up close to 200% in two weeks as the shorts rushed to cover.
As of January 29, there was a staggering 222.71 million shorted shares of FCX representing 21.75% of the float. In a one-month period, 45 million short positions were added. In this case, it was not that the stock market got it wrong on FCX stock; rather, it was that the shorts got squeezed by a rally in oil and copper prices. The company is a dud that is laden with massive debt and overpriced assets, but the shorts make it an intriguing trade, especially if oil and copper prices can resume their rise.
In the energy patch, I recently talked about Chesapeake Energy Corporation (NYSE:NYSE:CHK), which has skyrocketed more than 200% in a month on massive short covering.
As I said in the article, Chesapeake is hemorrhaging for air. It is surging not because there is optimism for its future, but because oil has rallied and there was an astounding 224.8 million shorted shares as of January 29, representing a massive 43.84% of the float. Further rises in oil prices will make life difficult for short sellers, but they will put a smile on those brave enough to trade from the long side either via the stock or call options.
Another prospect for a short squeeze that has yet to materialize is troubled Lumber Liquidators Holdings Inc (NYSE:LL), which is facing massive short selling after findings revealed high levels of cancer-causing chemicals in its Chinese-made laminate.
Hedge fund manager Whitney Tilson just re-entered into a new short position on LL stock and said there was 50/50 chance of a bankruptcy.
LL stock is trading at $11.89, just north of its low of $10.01 on February 29 and well down from its 52-week high of $37.78 in March 2015. Now, if the company can address and rectify the concerns including what could be massive lawsuits—which may be a long shot—the share price could surge, based on 8.74 million shorted shares, or 45.09% of the float, as of January 29.
For those with an inclination for risk and who are leaning toward the stock rebounding, you could consider playing a stock like LL via call options that extend from March to January 2018. For instance, if you believe in the long-term survival of LL, the January 2018 $10 call is available at $5.20. This means that if LL recovers and bounces back to above $15.20 by January 2018, you would be inline for some potentially nice gains.
Finally, there’s gourmet hamburger operator Shake Shack Inc (NYSE:SHAK), which I suggested was way overvalued in a commentary last year when the stock was trading at around $70.00. The stock is now languishing at $36.00 after disappointing metrics. Even with the selling, I still feel Shake Shack is overvalued and vulnerable to more selling.
Of course, if I’m wrong or if the momentum traders emerge, Shake Shack could surge, as 67.06% of the float was shorted as of January 29.
The bottom line is that there are always overpriced stocks at play that are intriguing as shorts. However, investors need to be aware that the massive short positions make them prone to price surges. Due diligence is key here.