A Tight Fit for Crocs' Shorts

It might be best to cover ahead of the crowd.
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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) - Get Report

, 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.

Crocs'

third-quarter earnings came in well ahead of analyst estimates last week, and the resulting 6.5% gap up was likely due in part to some short-covering. The problem for shorts now is that the stock is bumping up against resistance around $40. If it can work its way through $40, it could get really ugly really quick for those betting against it.

Whether you're long or short, if you're running with the crowd, it gets much tougher to come out ahead. If you're wrong, you'll be trying to make it to the emergency exit with the rest of the crowd.

Some other interesting retail plays that have high short ratios are

Under Armour

(UARM)

and

NutriSystem

(NTRI) - Get Report

, although neither chart is set up for as big a potential upside breakout as Crocs.

Please note that due to factors including low market capitalization and/or insufficient public float, we consider The Singing Machine to be a small-cap stock. You should be aware that such stocks are subject to more risk than stocks of larger companies, including greater volatility, lower liquidity and less publicly available information, and that postings such as this one can have an effect on their stock prices.

In keeping with TSC's editorial policy, Larsen Kusick doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships.

Kusick is a research associate at TheStreet.com, where he works closely with Jim Cramer and works on TheStreet.com Stocks Under $10. Prior to joining TheStreet.com, he worked in options trading and management consulting. He appreciates your feedback;

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