Is Martha Stewart's Run-Up a Good Thing?

Updated from 7:19 a.m. EDT

So, just what is up with shares of Martha Stewart Living (MSO Quote)?

The company's namesake and founder is headed to prison for a five-month stay after being convicted of obstruction of justice; the company has posted a loss in five of its last seven quarters; advertisers have fled its flagship title, Martha Stewart Living, like rats from a ship; and the company's turnaround hopes rely on the strategy of launching magazines and television shows without what was the company's most valuable asset: Stewart's imprimatur.

Despite all this, the company's stock price has jumped by one-third since Stewart asked to serve her prison term as soon as possible. On Tuesday, shares rose $1.64, or 12.5%, to $14.81. The stock is now trading where it was immediately before Stewart was convicted, when optimism about the trial's outcome pushed shares upward.

"I have no idea why it's here," said one fund manager, who asked not to be named and doesn't have a position in the company. "People do crazy stuff."

Indeed, the fund manager and other investors believe the run-up has little to do with fundamentals or a newfound faith in the company's prospects. Instead, they attribute the movement to the massive short position in the company's shares. As of the second week of September, the number of shares being shorted was equal to about 41% of the company's float.

"A lot of people are short this thing," said Stephen Monticelli, president of Mosaic Investments. "You've got some people throwing in the towel." (Monticelli's fund has no position in Martha Stewart Living.)

With other stocks, investors get nervous when the short ratio exceeds just 15% of a company's float. With such a high short ratio in Martha Stewart Living shares, any tidbit of good news can send the stock upward -- and generate a short squeeze and force short-sellers to the exits.