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Stay Away From These Four Heavily Shorted Stocks

So where else are the shorts focused? Here's a quick look at four stocks, and why the shorts see downside ahead.

1. Chesapeake Energy (CHK - Get Report)

Even after responding to shareholder requests for a more responsible board of directors, and even after a nice rebound in natural gas prices, short sellers still hold 85 million shares short (which, admittedly is down 5 million from mid-June but still ranks as the 11th-highest short position on the NYSE). Shares, near $19, are actually showing some resilience, even after the Wall Street Journal continues to run a series of stories questioning the company's unstated financial relationships and perhaps overstated gas reserves estimates.

Chesapeake's bulls and bears both make a solid case, and shares are either wildly overvalued or undervalued, according to who you listen to. I can't make heads or tails of it myself. For further insight on this stock, you may want to read Nathan Slaughter's views on Chesapeake in his Scarcity & Real Wealth newsletter if you haven't already.

2. Rite Aid (RAD - Get Report)

Shares of this lagging drug store chain have fallen from above $2 in late March to a recent $1.33, which would typically lead short sellers to cash in their winning bet. But they actually boosted the short position by six million shares to 58.8 million at the end of June.

Any time you see a stock trading below $2 with a large short position, you might wonder if this is a candidate for bankruptcy. Will that be the case?

Well, Rite Aid is sitting on more than $6 billion in debt. This means the retailer needs to pay out $130 million in interest expense every quarter. That's a larger sum than operating income, which means that Rite Aid continues to generate quarterly net losses. You can't do that in perpetuity if you have $6 billion in debt.

3. Arch Coal (ACI)

After scoring a big hit with Patriot Coal, short sellers are targeting this debt-laden rival. As is the case with Rite Aid, Arch Coal has to make huge quarterly interest payments -- roughly $75 million per quarter. Trouble is, the coal miner had just $54 million in operating income in the first quarter -- yielding a net loss -- and second-quarter results are likely to be even worse as coal prices keep on dropping.
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