A Tight Fit for Crocs' Shorts

This column was originally published on RealMoney on Nov. 6 at 2:11 p.m. EST. It's being republished as a bonus for TheStreet.com readers.

The profits have yet to come for anyone betting against Crocs (CROX), the maker of the immensely popular footwear of the same name. With the number of bets against this company steadily growing every month, it may be a good idea to cover those short positions before the rest of the crowd.

Short-sellers on Wall Street love the proverbial one-trick pony, especially in the retail sector, where the explosive earnings growth driven by a fad can push a stock up quickly, as analysts struggle to estimate the long-term growth rate.

One example of this is The Singing Machine (SMD). Back in 2002, the popularity of the company's karaoke machines pushed shares above $15. Over the next two years, the stock steadily plummeted and now sits below 40 cents. Obviously, spotting a company with an unsustainable growth rate attached to it can be mighty profitable.

The overall short position on Crocs has been building steadily, increasing from 19.9% of the float on July 9 to 38.6% on Oct. 10. In the meantime, the share price has gone from just below $25 to almost $40, resulting in some serious pain for those waiting for signs of sales deterioration.

The problem is that when everyone is employing the same strategy, it becomes harder for it to work. If 40% of Crocs' stock is already sold short, there has to be a serious blowup in order to get even more traders to sell the shares. On the other hand, if the company raises guidance or shows a sustainable growth rate, more buyers can quickly push the price up further. This could set off the fabled short squeeze: If all the shorts are running for the exits and buying shares to cover their ill-fated bets while other investors are also buying, the stock can gap up in a hurry.