This post-season, betting against the Arizona Cardinals -- ignoring the point spread -- would have proved unprofitable, even though that was the consensus view. They were the clear underdogs in their matchup against the Eagles on Sunday -- and throughout the post-season.
That's not to say they will overcome the ferocious defense of the Pittsburgh Steelers in the Super Bowl. But be careful of the conventional wisdom. Banking on the favorite -- in football or investing -- can trip you up. The Cardinals demonstrated that an underdog can score an upset.
Case in point: The late Adolf Merckle's big bet against
last year. The German entrepreneur is said to have lost many millions on a short-selling position after
announced in late October that it had acquired up to 75% of Volkswagen in stock and options. Porsche's move dried up trading volume, and some short sellers -- including the unfortunate Merckle, who threw himself under a train -- were forced to pay triple the price to cover their positions.
My deep-in-the-money options system doesn't involve short-selling. I place bets on undervalued stocks that I expect to rise. Yet, I keep my eye on short-selling behavior. There's plenty to be learned from looking at a simple metric of their activity: the short-interest ratio. That figure is the number of shares shorted divided by the average daily trading volume.
The ratio lets short sellers know how many days, in theory, it will take to cover their positions. And the ratio helps the rest of the market quickly see the potential for trouble with the stock. For example, short-selling on
surged in the days before its collapse as the market began to suspect it was short of cash.
A low ratio -- 1.0 or below -- is considered good.
, which has a solid balance sheet and is due to report earnings Thursday, has such a ratio -- 0.9 on Friday, using a three-month average trading volume.
is even better, at just 0.8.
Higher ratios -- especially 5 and above -- are viewed as danger signs. For example, troubled satellite programming provider
Sirius XM Radio
had a short ratio of 5.3 in early December, when the number of shares shorted was 263.8 million, or 7.6% of the float. The company was carrying a heavy debt load, with $1 billion coming due this year. Shortly thereafter, Sirius issued shares to pay down some of the debt coming due in February. As a result, the company's short ratio recently dropped by a full day -- to 4.4.
has also seen a big drop in short interest, bringing its ratio down to 2.3 days, from 3.0 in mid-December.
short ratio went in the opposite direction this month, after the company disclosed that sales have dropped off. In December, the ratio was 1.3, based on its three-month average volume. Following Intel's dismal earnings report last week and inability to predict its revenue outlook, the short ratio rose Friday to 1.5.
In the banking sector,
Bank of America's
ratio rose from 0.84 in mid-December to 0.91 late last week, after the company disclosed it needed more bailout money to stem losses from its acquisition of
ratio rose last week after the board appointed a new chief executive. It would now theoretically take a short seller 1.4 days to cover a position, down from 1.6 in mid-December. Likewise,
Research in Motion's
short ratio improved to 0.53 after posting a good earnings report, from a ratio of 0.6 in mid-December.
So keep your eye on those shorts. And don't count out an underdog until the coach is drenched in Gatorade.
Always remember: Life is a journey, enjoy the ride!
Lenny Dykstra manages Nails on the Numbers, a subscription service sold by TheStreet.com. Click here for a free trial to Nails on the Numbers. Mr. Dykstra writes regularly about options trades for TheStreet.com
At the time of publication, Dykstra had no positions in stocks mentioned.
Nicknamed 'Nails' for his tough style of play, Lenny is a former Major League Baseball player for the 1986 World Champions, New York Mets and the 1993 National League Champions, Philadelphia Phillies. A three time All-Star as a ballplayer, Lenny now serves as president for several privately held businesses in Southern California. He is the founder of The Players Club; it has been his desire to give back to the sport that gave him early successes in life by teaching athletes how to invest and protect their incomes. He currently manages his own portfolio and writes an investment strategy column for TheStreet.com, and is featured regularly on CNBC and other cable news shows. Lenny was selected as OverTime Magazine's 2006-2007 "Entrepreneur of the Year."