Kass: How to Short

Editor's note: These posts by Doug Kass are a special bonus for TheStreet.com and RealMoney readers. They first appeared on Street Insight on March 30. To sign up for Street Insight, where you can read Kass' commentary in real time, please click here.

As a dedicated short-seller, I incorporate some basic tenets and disciplines in my portfolio management.

One of those principles is to avoid hard-to-borrow and heavily shorted stocks.

Yesterday, Dendreon (DNDN - Cramer's Take - Stockpickr) announced that the Food and Drug Administration said its Provenge drug (the first active cellular immunotherapy and the first biologic approved to treat prostate cancer) was safe and that there was "substantial evidence of efficacy."

DNDN has a float of 80 million shares; its average trading volume is about 3 million shares a day. However, short interest totals 20.3 million shares (up nearly 4 million shares from the prior month), or about 25% of the float!

I avoid heavily shorted stocks in which short interest is a large percentage of the float or shares outstanding, such as at Dendreon. To me, high short interest is a nonstarter.

DNDN closed at $5.12 a share on Wednesday (it didn't trade on Thursday) and is currently trading up by over 230% to $17 in the premarket!

DNDN is a classic example of why a short-seller should avoid heavily shorted stocks.

Fundamentals Are Fading Fast

Month-to-date, the S&P 500 index is up by over 1% in March. It is safe to say (barring an extreme event) that March will likely end up positively, which would put 13 out of the last 15 months in positive territory.

Despite this extraordinary (and historically abnormal) run, at the slightest downtick, I sense a lot of angst in the market by hedge fund operators. From my perch, this means that investors (especially the hedge fund -- and fund of fund -- kind) are far more long (or levered) than most surveys reveal.