Stock Quotes in this Article: DMND, FNSR, SIGA

WINDERMERE, Fla. (Stockpickr) -- Once again, we're seeking out stocks that look poised for an earnings short squeeze.

 

These stocks could make big moves to the upside if the bears are caught leaning the wrong way. Market bears short stocks for a lot of reasons, including poor fundamentals, overvaluation and poor technical chart patterns. But even the best short-seller can get caught short the wrong stock prior to a company’s earnings report. If a stock is heavily shorted going into an earnings report and the company delivers bullish results, the stock is primed to explode to the upside.

On the flipside, if a stock is heavily shorted prior to an earnings report and the company fails to deliver strong results, then the bears will have an open season to knock a stock down substantially. It's a strategy that comes with a lot of risk but also has the potential for great reward. A short squeeze can be the start of a major trend that takes a stock higher for days and even weeks, which is why I love to look for earnings short-squeeze candidates because; when they do occur, market players can make some big money.

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    It’s important when trading an earnings short squeeze candidate to always use a disciplined trading approach. If the short squeeze doesn’t materialize, then it's best to just cut your losses and move on. But keep in mind that sometimes a stock won’t start on its short-squeeze mission until a day or two following the earnings. It can take some time for big institutional investors to digest all of the results and start to place their trades.

    That’s exactly what happened to Sina (SINA), which was one of my earnings short-squeeze picks last week. The stock initially fell after it reported their results, all the way down to $74.22 a share, and then it proceeded to start a short squeeze that took the stock back up to $84 in just two trading sessions.

    Before we take a look at some potential earnings short-squeeze candidates, let’s go over the basics. A short squeeze is a rapid increase in the price of a stock that occurs when there is a lack of supply and an excess of demand for the stock. Short squeezes happen when bears who’ve sold the stock short are forced to cover their position on a stock as it rises. Short sellers will cover their positions to avoid losses further losses.

    Here's a look at a number of stocks that could experience a big short squeeze when they report earnings this week.

    Finisar

    My first idea for an earnings short squeeze trade is Finisar (FNSR), which is scheduled to report its results on Tuesday after the market close. This company designs, develops, manufactures, and markets optical subsystems and components that are used to interconnect equipment in short-distance local area networks (LANs), storage area networks (SANs), longer distance metropolitan area networks (MANs), fiber-to-the-home networks, cable television networks and wide area networks. This stock is off to a blazing start in 2011 with shares up over 37%. Wall Street analysts are expecting the company to report revenue in a range of $254.2 million to $265 million and earnings per shares of 45 cents to 48 cents.

    This company is a fast-growing play on the booming optical network market that’s being driven by the rapid increase in data usage from cloud computing and wireless devices. What will matter most for this company is the guidance that it provides on its earnings call. We saw on Monday with competitor Ciena (CIEN) what happens to an optical player that doesn't issue bullish guidance -- in Ciena's case, it provoked a drop of over 8% for the stock. If you’re a bull on Finisar, you should be hoping that the weak guidance from Ciena is due to some market share gains for Finisar.

    The current short interest as a percentage of the float for FNSR sits at around 10.3%. That means that out of the 71.46 million shares that are available for trading, 8 million shares are currently sold short by the bears as of Feb. 15. It’s worth noting that the shorts have been increasing their bets by around 6.1%, or about 450,000 shares. If these bears are pressing too much in front of the quarter, they could easily get caught in a big short squeeze.

    From a technical standpoint, this stock has a ton of past overhead resistance at around $44 to $46 a share. There is also some strong support for the stock at around $37 to $38 a share. I would like to see this stock hold those support levels and start to make a run at those resistance levels to confirm that an earnings short squeeze could be in the cards. If it breaks those support levels, I would sell it immediately because it probably means it’s going to slice right through the 50-day moving average at $35.55 a share.

    Basically, a move above $44 either before or after the quarter would have me jumping into the stock to capture some quick profits driven by short covering.

    In the most-recent quarter, Lee Ainslee's Maverick Capital initiated a new position of 4.3 million shares in Finisar.

    Siga Technologies

    Another stock that could be setting up nicely for an earnings short squeeze is Siga Technologies (SIGA), which is due to report its results on Wednesday after the market close. This bio-defense company engages in the discovery, development and commercialization of products for use in defense against biological warfare agents comprising smallpox and arenaviruses. This stock is off to a pretty slow start in 2011 with shares only up by around 6.2%. There are only four analysts that cover this company, and they’re currently projecting a wide range of results, with revenue in the range of $4 million to $23.63 million and earnings-per-share in the range of a10-cent loss to a 34-cent profit.

    What I like most about this stocking going into the quarter is the bullish technical trading action. Shares of Siga just recently started to form a breakout chart pattern. The stock has started to trade above some past overhead resistance at around $14.25 to $14.40 a share on heavy volume. In fact, the breakout occurred on two days of volume that each saw over 800,000 shares trade, which is easily above the three-month average action of just 388,000 shares. This strong uptrend is a great sign to see going into their earnings report.

    Now, some of the recent upside speculation in the stock is due to the potential of a big government contract to supply millions of doses of smallpox treatment for the national stockpile. This is another great reason to like the stock ahead of the quarter because I expect management to provide some color on the potential contract. Anything they say that’s bullish could easily spark a massive short squeeze. Keep in mind that a Wedbush Securities analyst recently said that if Siga gets the contract, it could results in a $500 million deal with the potential for a follow-on contract valued at $2.8 billion in annual sales. That would be a gigantic win for a company that brought in just $26 million in sales last year.

    The current short interest as a percentage of the float for Siga is a rather large 16.7%. That means that out of the 31 million shares in the tradable float around 5.75 million shares are currently sold short by the bears as of Feb. 15. This is a low float with a very high short interest that’s just the type of situation that can produce a massive short squeeze.

    From a technical standpoint, as long as this stock stays above the breakout levels mentioned above going into the quarter, then I would take a shot at going long this name. I would simply cut my trade and bailout if the stock started to trade below the breakout levels on heavy volume. Keep in mind this recent breakout has pushed the stock to brand new all-time highs at $15.50 a share.

    Diamond Foods

    One final stock that could be setting up for a large earnings short squeeze is Diamond Foods (DMND), which is due to report earnings on Tuesday after the market close. This company engages in processing, marketing and distributing snack products, as well as culinary, in-shell and ingredient nuts. Its snack products include glazed nuts, roasted and mixed nuts, breakfast trail mix products, microwave popcorn products, and potato and tortilla chips. This stock hasn’t done much to excite the bulls this year, with shares actually down by 3.3%. Wall Street analysts are looking for revenues to come in between $260.70 million to $270.40 million and for earnings per share to be in a range of 86 cents to 95 cents.

    One of the reasons I like Diamond Foods going into this report is that another consumer goods stock B&G Foods (BGS) recently delivered a very strong earnings report that sent their stock skyrocketing. We all know that food prices are rising rapidly thanks to the raging bull market that’s occurring in soft commodities. If Diamond Foods has been able to successfully pass along some of those rising costs to their customers, then the company could easily deliver a strong quarter. B&G Foods has a much different product mix with shelf-stable foods than Diamond, but another reason why I like Diamond is that it's solely focused on snack foods.

    Diamond Foods basically sells comfort foods such as popcorn, nuts and potato chips. I doubt Diamond had a lot of trouble with passing along rising costs, since I doubt consumers stopped buying comfort foods that have gone up in price marginally. These types of products would need to go up dramatically in price to see a noticeable decline in sales, since they aren’t a staple for most consumers.

    As of Feb. 15, the current short interest as a percentage of the float for DMND is a rather large 26.67%. That means that out of the 21.33 million shares in the tradable float around 5.65 million shares are currently sold short by the bears. Again, this is another case of a huge short interest and very low tradable float situation.

    From a technical standpoint, this stock has started to make a run at the 50-day moving average of $51.66 a share. If this stock can manage to take out some near-term overhead resistance at around $52.71, then I think we could easily see a short squeeze that takes this back to the 52-week high of $55.97 if not even higher. Any volume on Tuesday that clocks in at over 200,000 shares as the stock goes up should also increase the chances that the stock is being accumulated prior to their earnings report.

    To see more potential earnings short squeeze candidates, check out the Earnings Short-Squeeze Plays portfolio on Stockpickr.

    -- Written by Roberto Pedone in Winderemere, Fla.

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    At the time of publication, author had no positions in stocks mentioned.

    Roberto Pedone, based out of Windermere, Fla., is an independent trader who focuses on stocks, options, futures, commodities and currencies. He is also an outside contributor to Beconequity.com and maintains the website Maddmoney.net, which he sold to Blue Wave Advisors in 2008. Roberto studied International Business at The Milwaukee School of Engineering, and he spent a year overseas studying business in Lubeck, Germany.