Taking It To The Shorts

The stock market is on a tear this year. Since the calendar flipped over to 2023, the S&P 500 Index rose more than 8% in just five weeks. Tech stocks, as reflected by the Nasdaq Composite Index, gained nearly twice that amount. That’s great news for all the buy and hold index investors that took a bath last year. Another couple of months like January and last year will be all but forgotten.

However, the odds are against another couple of months like that in February and March. A more likely scenario is reversion to the mean, with stocks leveling off until the next big round of quarterly results are released in April.

However, that does not mean that there isn’t money to be made in the stock market until then. Last week, one of my stock market screeners identified a possible short squeeze in the making.

The good news is it isn’t too late to get in on the action. Further below, I’ll explain exactly how to do that.

But first, a quick review of what a short squeeze is and how it happens. When a company goes bankrupt, the value of its common stock is zero. That’s because it must first pay off its secured creditors in full, which consumes more than all the net assets the company has (otherwise, it wouldn’t be bankrupt in the first place).

For that reason, speculators will sell shares of the company now and buy them back later when they are cheaper (or possibly free). It’s the same objective all equity investors have – buy low, sell high – except in reverse.

Getting Back in the Game

However, if the company manages to avoid bankruptcy, short sellers will hustle to close out their positions. Sometimes, they must buy the stock back at a higher price than they sold it for, resulting in a loss.

In extreme cases, that can sometimes drive the share price up to extreme heights until the short sellers have closed out their positions. After that, the stock can just as quickly plummet back to where it was.

That is the dynamic that drove several “meme stocks” higher a few years ago. You may recall the meteoric rise of GameStop (NYSE: GME). A short squeeze in January 2021 drove its share price from below $5 to above $120 in less than a month!

One way to spot a potential short squeeze candidate is to look at the short interest, or shares sold short as a percentage of shares outstanding. When that number rises above 10%, that usually means that short sellers are targeting the company as a potential bankruptcy candidate.

Last week, short interest for Hanesbrands (NYSE: HBI) rose above 20%. The company has struggled to overcome supply chain disruptions since the onset of the coronavirus pandemic three years ago.

As a result, its share price tumbled from above $22 in May 2022 to below $6 at the end of last year. It rallied along with rest of the stock market in January, but then fell hard on February 2 after releasing its fiscal 2022 Q4 and full year results.

Those results came in above the company’s guidance for the quarter but were overshadowed by its modest expectations for the current year. In addition, it is eliminating its dividend so it can use that money to pay down debt.

Squeeze Play

That news is music to a short seller’s ears. However, the company also said that it expects “to exit (this) year with meaningfully higher gross and operating margin run-rates.” If that prediction proves true, now could be a good time to buy a call option on HBI while its share price is low [Disclosure: I own HBI call options in my personal account].

Last week while it was trading near $7, the call option that expires in January 2024 at the $8 strike price could be bought for $1. For this trade to be profitable, HBI must rise above $9 within a year. If it rises above $10 before the option expires, the return on this trade would by at least 100%.

I believe there is a good chance that will happen. I also think there is a decent chance that a short squeeze may drive HBI considerably higher than that in the interim.

Three months ago, I recommended buying a call option on HBI. That trade could have been closed out last week for a 50% profit. But if you missed out on that one, you have a second chance to get in on what may be a lucrative short squeeze opportunity.

Editor’s Note: In a new report, our colleague Dr. Joe Duarte pinpoints a groundbreaking tech disruption worth $75 trillion…and it all starts with one under-the-radar $3 stock.

Dr. Duarte is the chief investment strategist of our premium trading services, Profit Catalyst Alert and Weekly Cash Machine. He’s been making money from stocks for over 35 years, through some of the wildest market swings imaginable…from the explosive 1990s bull run to the devastating dot-com bust and Great Recession that marked the 2000s, and the historic 2010s bull market.

Dr. Duarte currently recommends an investment opportunity in the tech sector that’s poised for market-crushing gains. Learn more by clicking here.