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A Short-Squeeze Play for the Rate Cut

Here's a way to find stocks that could get pushed higher after the Sept. 18 meeting.

Editor's note: This column was submitted by Stockpickr member Roberto Pedone.

Sept. 18 is quickly approaching, and the key question for many traders is, how can I make some money off what seems to be a likely

Federal Reserve

rate cut? I am going to outline a trading strategy that could represent a good risk/reward trade for certain individual stocks if Mr. Bernanke decides to appease the market gods with a rate cut.

For my Fed rate cut indicator, I am going to use

Goldman Sachs

(GS) - Get Free Report

. From a psychological standpoint, as long as Goldman Sachs is trading higher going into the Fed meeting, then the conditions are right to look for potential short-squeeze candidates. The optimum situation would be if the Fed were to cut by 50 basis points, but predicting that is pretty much impossible.

The strategy is to look for a combination of stocks with a high short interest (10% or more) and stocks that are in depressed sectors tied to lending, housing,

private equity/hedge funds and retail. I will be ignoring fundamentals and paying attention to perception with my selections.

The goal is to select stocks that will trigger psychological reactions from traders that have little to do with the long-term fundamental outlook. A note of caution: These stocks are for the nimble, disciplined traders who can get in and out quickly if all the conditions line up and cause the short squeeze.

The first selection is

Bear Stearns


, atop-tier investment bank that specializes in securities and derivatives trading, clearance and brokerage services worldwide. Bear has been clouded by lots of negative news lately after two of the firm's hedge funds blew up. Also, Bear has exposure to subprime mortgages, and we all know that that has been a great catalyst for the short-sellers to take this stock down a some 30% in the last six months.

On Monday, news broke that savvy billionaire investor Joe Lewis acquired a 7% stake in Bear worth $860 million. With about 10% of the stock's float shorted, Bear Stearns meets one element of the strategy. If the perception from the market is that a Fed rate cut will elevate some of the pressure in subprime, then Bear should benefit, and the other side of the strategy is met.

The next play is

Beazer Homes USA

(BZH) - Get Free Report

. Beazer Homes engages in the design, building and sale of single-family homes throughout the U.S. This homebuilder has been absolutely annihilated, trading down more than 70% in the last six months. With subprime and housing fears circling this name, it's easy to see why the stock has been destroyed.

Many investors have been talking bankruptcy for Beazer, but a very smart hedge fund operator, Ken Griffin, who runs Citadel Investment Group, recently took a 5.7% stake in the company. The bears on Wall Street are grabbign at this name hand-over-fist, with a gigantic 70% of the float sold short. I see Beazer as a great short-squeeze candidate, but let's remember that this is a trading call, not an investment idea. A 50-point-basis cut would be helpful for this high-risk trade.

Another name that fits the strategy is

Fortress Investment Group


. Fortress is a global alternative asset manager that raises, invests and manages private-equity funds, hedge funds and publicly traded alternative investment vehicles. A Fed rate cut would lower the cost of capital, and we could expect that the market would perceive this as bullish for private-equity firms.

Private equity makes up 54% of assets for Fortress. A return to global liquidity with a rate cut would also be bullish for hedge funds that Fortress controls. Heck, it's possible that Fortress could make a killing by trading the Fed rate cut within its own hedge funds. Some 12% of the float is short, and the stock is off 32% in the last six months. So if the strategy works, a short squeeze could be in order.

To see the rest of this week's picks -- including

NovaStar Financial



Blackstone Group

(BX) - Get Free Report


Countrywide Financial


, check out the

10 Stocks That Could Short Squeeze If the Fed Cuts Rates

portfolio at

At the time of publication, Pedone had no positions in stocks mentioned, although positions may change at any time.

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