DELAFIELD, Wis. (Stockpickr) -- Short-sellers hate being caught short a stock that reports a blowout quarter. When this happens, we often see a tradable short squeeze develop as the bears rush to cover their positions to avoid big losses. Even the best short-sellers know that it's never a great idea to stay short once a bullish earnings report sparks a big short-covering rally.
This is why I scan the market for heavily shorted stocks that are about to report earnings. You only need to find a few of these stocks in a year to help enhance your portfolio returns -- the gains become so outsized in such a short time frame that your profits add up quickly.
That said, let's not forget that stocks are heavily shorted for a reason, so you have to use trading discipline and sound money management when playing earnings short-squeeze candidates. It's important that you don't go betting the farm on these plays and that you manage your risk accordingly. Sometimes the best play is to wait for the stock to break out following the report before you jump in to profit off a short squeeze. This way, you're letting the trend emerge after the market has digested all of the news.
Of course, sometimes the stock is going to be in such high demand that you risk missing a lot of the move by waiting. That's why it can be worth betting prior to the report -- but only if the stock is acting technically very bullish and you have a very strong conviction that it is going to rip higher. Just remember that even when you have that conviction and have done your due diligence, the stock can still get hammered if Wall Street doesn't like the numbers or guidance.
If you do decide to bet ahead of a quarter, then you might want to use options to limit your capital exposure. Heavily shorted stocks are usually the names that make the biggest post-earnings moves and have the most volatility. I personally prefer to wait until all the earnings-related news is out for a heavily shorted stock and then jump in and trade the prevailing trend.
With that in mind, let's take a look at several stocks that could experience big short squeezes when they report earnings this week.
My first earnings short-squeeze trade idea is fast casual Mediterranean cuisine restaurant player Zoe's Kitchen (ZOES), which is set to release numbers on Thursday after the market close. Wall Street analysts, on average, expect Zoe's Kitchen to report revenue of $61.52 million on a loss of 1 cent per share.
The current short interest as a percentage of the float for Zoe's Kitchen is extremely high at 27%. That means that out of the 18.67 million shares in the tradable float, 5.28 million shares are sold short by the bears. The bears have also been increasing their bets from the last reporting period by 7%, or by about 360,000 shares. If the bears get caught pressing their bets into a bullish quarter, then shares of ZOES could easily spike sharply higher post-earnings as the bears move fast to cover some of their positions.
From a technical perspective, ZOES is currently trending below both its 50-day and 200-day moving averages, which is bearish. This stock recently formed a double bottom chart pattern, after shares found buying interest at $30.02 to $30.25 a share. Shares of ZOES have started to trend modestly higher off those support levels and it's beginning to trend within range of triggering a near-term breakout trade post-earnings.
If you're bullish on ZOES, then I would wait until after its report and look for long-biased trades if this stock manages to break out above its 50-day moving average of $32.72 a share and then above some near-term overhead resistance levels at $33.46 to $33.59 a share with high volume. Look for volume on that move that hits near or above its three-month average action of 385,005 shares. If that breakout triggers post-earnings, then shares of ZOES will set up to re-test or possibly take out its next major overhead resistance levels at $35.67 to its 52-week high of $38.42 a share. Any high-volume move above $38.42 will then give ZOEZ a chance to tag or trend north of $40 a share.
I would simply avoid ZOES or look for short-biased trades if after earnings it fails to trigger that breakout and then drops back below some key near-term support levels at $30.25 to $30.02 a share with high volume. If we get that move, then ZOES will set up to re-test or possibly take out its next major support levels at $28.10 to its 52-week low of $27.09 a share. Any high-volume move below $27.09 will then set up ZOES to tag or trend below $25a share.
Another potential earnings short-squeeze trading opportunity is specialty value retailer Five Below (FIVE), which is set to release numbers on Wednesday after the market close. Wall Street analysts, on average, expect Five Below to report revenue $151.32 million on earnings of 7 cents per share.
The current short interest as a percentage of the float for Five Below is extremely high at 20%. That means that out of the 52.71 million shares in the tradable float, 11.03 million shares are sold short by the bears. This is a large short interest on a stock with a relatively low tradable float. If the bulls get the earnings news they're looking for, then shares of FIVE could easily ramp sharply higher post-earnings as the bears move fast to cover some of their positions.
From a technical perspective, FIVE is currently trending below both its 50-day and 200-day moving averages, which is bearish. This stock has been for the most part consolidating and trending sideways over the last two months, with shares moving between $31.82 on the downside and $37.43 on the upside. Shares of FIVE have now started to spike above some near-term support at $32.83 and it's beginning to trend within range of triggering a big breakout trade above the upper-end of its recent sideways trending chart pattern.
If you're in the bull camp on FIVE, then I would wait until after its report and look for long-biased trades if this stock manages to break out above some key overhead resistance levels at $34.97 to $36.47 a share and then above $37.43 a share with high volume. Look for volume on that move that registers near or above its three-month average volume of 1.15 million shares. If that breakout gets started post-earnings, then FIVE will set up to re-fill some of its previous gap-down-day zone from January that started near $44 a share.
I would simply avoid FIVE or look for short-biased trades if after earnings it fails to trigger that breakout and then drops back below some key near-term support levels at $32.83 to $31.82 a share with high volume. If we get that move, then FIVE will set up to re-test or possibly take out its next major support levels at $30 to $29 a share, or even its 52-week low of $28.51 a share.
Chris Laudani says that first-quarter results should be "catalyst the stock needs to move much higher," and Richard Saintvilus thinks the stock is still undervalued.