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J.C. Penney Can Crush Shorts and Longs

NEW YORK (TheStreet) -- Consumers on the lookout for the best deals know J.C. Penney (JCP - Get Report) is in the midst of a battle royale for survival against Wal-Mart (WMT), Target (TGT), Sears (SHLD), Kohl's (KSS) and Macy's (M), among others. Like gladiators, these champions of retail fight to the death. For investors and money managers, there's another important battle waging in retail -- this one regards analysts' opinions.

For J.C. Penney, it's the fight between analysts at Goldman Sachs (GS) and Citigroup (C).

Goldman's Take

Goldman Sachs all but said J.C. Penney is finished, and note holders should consider credit default swaps to protect against losses. A credit default swap is a form of bond insurance and has characteristics of a binary option, it pays the buyer in the event the underlying bonds default.

Credit default swaps don't help shareholders, however, bond holders have priority over shareholders during a liquidation. If bond holders have reason to worry, shareholders should be shaking in their boots.

Upon learning Goldman's opinion, shareholders acted as expected and exited J.C. Penney positions en masse. When the smoke cleared, the shares fell below the immensely influential $5 level, and the shareholder base shifted to new owners, based on the elevated volume.

Markets move day to day based on emotion, and after enough years of screen time, one gains a sense of when the market may bounce. In Profit From J.C. Penney's Panic Selling and in Real Money Pro, I offered a bull thesis, and that's paid off in spades. The selloff set up a dead-cat bounce, which in turn set short-sellers in motion.

The company has a short interest of almost half the float. That's a lot of smart money betting the shares remain overpriced relative to the company's prospects, but if something -- anything -- is able to renew interest in the stock, shorts run for cover, sending shares higher as they exit.

Starting about a week ago, shorts likely started to lock in gains. We don't know for sure, because short-interest data are not in real time; albeit following the well-received earnings report, it's logical, based on historical observations. Shorts who did not cover received a wake-up call on why they should have, on Tuesday.

Citigroup's Take

As outlined by TheStreet's Shawn Ingram, Citigroup upgraded the beleaguered retailer from neutral to buy, sending shares up 9% before lunch Tuesday. Analysts at Citigroup cited improving margins and product mix as factors. In other words, the analysts at Citigroup believe the number crunchers at Goldman Sachs have it wrong, and J.C. Penney will make it through to the other side.

Citigroup's timing is curious. Maybe it smelled short-seller blood in the water and released the upgrade now, knowing that it could spark a short squeeze. Perhaps it came to the opposite conclusion as Goldman Sachs in isolation, but I would wager it was a combination of the two. Either way, it worked, based on the soaring share price.

My Take

Where does this leave shareholders?

I believe J.C. Penney has legs and will break above into double digits, but not without significant volatility.

In moves above $9, I would take some gains off the table and reload again below $8. Another attractive strategy for fast-moving stocks is to sell covered calls and take advantage of the heightened volatility. For example, the May $10 call options can be sold for about 70 cents. You limit your upside to $10.70, but a covered call will dampen the roller-coaster ride while lowering your risk.

Selling calls is especially useful for investors who want to take some gains without actually selling their position.

At the time of publication, Weinstein had no positions in securities mentioned.

Follow @RobertWeinstein

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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