Profiting off of an earnings season short squeeze

     While going through news about each of my holdings yesterday, I came across a great article on TheStreet.com, about how to play short squeezes that occur during earnings season.  For those who might be unfamiliar, a short squeeze occurs when a stock is heavily shorted, but for whatever reason, the stock price begins to climb higher and higher.  When this happens, those who are short on the stock begin to panic and start buying to cover their positions and get out.  What typically happens is that every short seller tries to cover around the same time, placing tremendous buying pressure (and artificial demand) on what is often an insufficient supply of shares. This forces the price up even higher, perhaps triggering even more short sellers to cover.  This phenomenon is known as a short squeeze, and it is easy to see why earnings season is a ripe time for these to occur.  High flying, rapidly increasing growth stocks are often the target of short sellers, who may think that a particular stock's tremendous growth is unsustainable and is due to end soon.  However, these same stocks often continue to post superb earnings, which naturally drive prices higher (and can trigger a short squeeze).  This combination of events can result in enormous gains for those who are long on these stocks. To capitalize on this, a speculator can enter a long position in a stock that he has analyzed and determined will likely beat earnings estimates, but which has a high float short percentage. A tight stop loss can be placed on the day of the earnings report, and if it goes as expected, he can expect a huge profit as a short squeeze will likely occur. What the article did was explain this strategy, and provide a few possible short squeeze situations.  One suggestion given was Whole Foods Market, Inc (WFMI), who reported earnings after the close yesterday. Earnings came out positive, and the stock gapped up and rose almost 12% today! Intuitively, this strategy is brilliant, focusing clearly on finding tangible situations in which demand will greatly outpace supply.  For those who read my last post, you know the importance I place on keeping these basic economic principles in mind for every strategy.  If I can find a suitable candidate, I may try this out in the near future.

Whole Foods Market, Inc's short squeeze today

As I have mentioned in my last couple posts, I am anticipating a correction in the overall market very soon, and was confident enough to buy put options on the S&P 500 tracking ETF SPY.  The index fell yesterday on above average volume, just as I expected, and fell early on today, as well. However, a late rally pushed the index barely back into the positives, where it finished. As a result, my options position suffered a hit, but I am still confident that the market will definitely correct over the next few weeks.  I've noticeably trimmed down my stock holdings over the past week in anticipation for the correction, with now just two positions of 100 shares each.  Both APKT and LULU netted solid gains for me today, as did ZAGG (which I have call options on).  However, the loss in value of my SPY options mostly offset these gains, and I finished pretty flat.  

Thursday, February 10th, 2011

Daily Change: Up $429.50 (2.15%)

Current Porfolio Value ($20000 on January 24th, 2011): $21744.00  (Up 8.7%)

February Performance: Up $2449.04 

Market Outlook: Bullish but have been anticipating a correction since last Friday...flat day today doesn't mean much to me. The market opened up low, however, and finished higher, which tends to signal buying pressure. However, much of the late rally was caused by what seemed to be good news (Egypt's President giving a speech where he was expected to step down, but did not), so under other circumstances this could easily have been a distribution day on above average volume. I still believe that a correction is imminent.

Holdings:

APKT - 100 shares - $73.86/share

LULU - 100 shares - $82.77/share

SPY Feb 19 $130.00 Put - 10 contracts - $0.54

ZAGG May 21 $10.00 Call - 5 contracts - $1.38

Trades: Thursday, February 10th, 2011

None.