Stock Quotes in this Article: DGX, IRBT, NFLX, RMD, VMW

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.

 

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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 The Street doesn't like the numbers or guidance.

 

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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, here's a look at several stocks that could experience big short squeezes when they report earnings this week.

 

Netflix

 

My first earnings short-squeeze play today is Internet television network player Netflix (NFLX), which is set to release numbers on Monday after the market close. Wall Street analysts, on average, expect Netflix to report revenue $1.27 billion on earnings of 83 cents per share.

 

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Just recently, Pacific Crest upgraded shares of Netflix to outperform from sector perform on expectations that the company's international growth will accelerate meaningfully over the next 18 months. Pacific Crest has a $500 price target on the shares.

 

The current short interest as a percentage of the float for Netflix is notable at 6.8%. That means that out of the 58.60 million shares in the tradable float, 3.91 million shares are sold short by the bears. This isn't a huge short interest, but it's more than enough to spark a decent short-covering rally post-earnings if the bulls get the earnings news they're looking for.

 

From a technical perspective, NFLX is currently trending right at its 200-day moving average and well below its 50-day moving average, which is neutral trendwise. This stock has been downtrending badly over the last two months, with shares moving lower from its high of $458 to its recent low of $312.10 a share. During that downtrend, shares of NFLX have been consistently making lower highs and lower lows, which is bearish technical price action. That said, shares of NFLX have started to bounce off that $312.10 low and it's starting to move within range of triggering a near-term breakout trade post-earnings.

 

If you're bullish on NFLX, then I would wait until after its report and look for long-biased trades if this stock manages to break out above some near-term overhead resistance levels at $349.73 to $357.48 a share with high volume. Look for volume on that move that hits near or above its three-month average action of 3.16 million shares. If that breakout triggers post-earnings, then NFLX will set up to re-test or possibly take out its next major overhead resistance levels at $370 to its 50-day moving average of $401.63 a share.

 

I would simply avoid NFLX or look for short-biased trades if after earnings it fails to trigger that breakout and then drops back below some near-term support levels at $330 to $320 a share with high volume. If we get that move, then NFLX will set up to re-test or possibly take out its next major support levels at $312.10 to $309 a share. Any high-volume move below those levels will then give NFLX a chance to re-test or drop below its next major support level at $282 a share.

 

iRobot

 

Another potential earnings short-squeeze trade idea is iRobot (IRBT), which designs, develops and markets robots for consumer, defense and security, telemedicine and video collaboration markets worldwide. iRobot is set to release its numbers on Tuesday after the market close. Wall Street analysts, on average, expect the company to report revenue $112.26 million on earnings of 16 cents per share.

 

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The current short interest as a percentage of the float for iRobot is extremely high at 26.1%. That means that out of the 27.97 million shares in the tradable float, 7.24 million shares are sold short by the bears. The bears have also been increasing their bets from the last reporting period by 19.2%, or by about 1.16 million shares. If the bears get caught pressing their bets into a bullish quarter, then shares of IRBT could easily jump sharply higher post-earnings as the shorts rush to cover some of their bets.

 

From a technical perspective, IRBT is currently trending above its 200-day moving average and just below its 50-day moving average, which is neutral trendwise. This stock has been downtrending over the last month and change, with shares moving lower from its high of $48.36 to its recent low of $35.50 a share. During that move, shares of IRBT have been making mostly lower highs and lower lows, which is bearish technical price action. That said, shares of IRBT have started to bounce off that $35.50 low and its moving back above its 200-day moving average. That move is starting to push shares of IRBT within range of triggering a near-term breakout trade post-earnings.

 

If you're in the bull camp on IRBT, then I would wait until after its report and look for long-biased trades if this stock manages to break out back above its 50-day moving average of $41.58 a share with high volume. Look for volume on that move that hits near or above its three-month average action of 1.13 million shares. If that breakout hits post-earnings, then IRBT will set up to re-test or possibly take out its next major overhead resistance levels at $45 to its 52-week high at $48.36 a share. Any high-volume move above $48.36 will then give IRBT a chance to trend north of $50 a share.

 

I would simply avoid IRBT 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 at $35.50 a share with high volume. If we get that move, then IRBT will set up to re-test or possibly take out its next major support levels at $33 to $29 a share.

 

VMware

 

Another potential earnings short-squeeze candidate is VMware (VMW), which provides virtualization infrastructure solutions in the U.S. and internationally. VMware is set to release numbers on Tuesday after the market close. Wall Street analysts, on average, expect the company to report revenue of $1.35 billion on earnings of 79 cents per share.

 

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Just recently, CLSA upgraded shares of VMware to outperform on expectations the company is best positioned to capitalize on the software defined data center segment. The firm raised its price target on the stock to $115 a share from $99 a share.

 

The current short interest as a percentage of the float for VMware is very high at 23%. That means that out of the 80.64 million shares in the tradable float, 18.46 million shares are sold short by the bears. The bears have also been increasing their bets from the last reporting period by 1.5%, or by about 272,000 shares. If the bears get caught pressing their bets into a strong quarter, then shares of VMW could easily surge sharply higher post-earnings as the shorts jump to cover some of their positions.

 

From a technical perspective, VMware is currently trending above both its 50-day and 200-day moving averages, which is bullish. This stock has been uptrending for the last three months, with shares moving higher from its low of $86.88 to its recent high of $112.89 a share. During that move, shares of VMW have been making mostly higher lows and higher highs, which is bullish technical price action.

 

If you're bullish on VMW, then I would wait until after its report and look for long-biased trades if this stock manages to break out above some near-term overhead resistance levels at $104.50 to $107.50 a share with high volume. Look for volume on that move that hits near or above its three-month average action of 2.43 million shares. If that breakout kicks off post-earnings, then VMW will set up to re-test or possibly take out its 52-week high at $112.89 a share. Any high-volume move above that level will then give VMW a chance to tag or take out $120 a share.

 

I would avoid VMW 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 $100 to $98.88 a share with high volume. If we get that move, then VMW will set up to re-test or possibly take out its next major support level at $92.73 to its 200-day moving average at $88.55 a share.

 

ResMed

 

Another earnings short-squeeze prospect is medical equipment player ResMed (RMD), which is set to release numbers on Wednesday after the market close. Wall Street analysts, on average, expect ResMed to report revenue of $400.01 million on earnings of 64 cents per share.

 

The current short interest as a percentage of the float for ResMed is extremely high at 25.6%. That means that out of the 139.26 million shares in the tradable float, 35.89 million shares are sold short by the bears. The bears have also been increasing their bets from the last reporting period by 5%, or by about 1.72 million shares. If the bears get caught pressing their bets into a bullish quarter, then shares of RMD could easily trend sharply higher post-earnings as the shorts rush to cover some of their positions.

 

From a technical perspective, RMD is currently trending above its 50-day moving average and just below its 200-day moving average, which is neutral trendwise. Shares of RMD have started to flirt with a near-term breakout trade today, since the stock has tested some past overhead resistance at $48.07 a share. That move is starting to push shares of RMD within range of triggering a much bigger breakout trade post-earnings.

 

If you're bullish on RMD, 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 $51.22 to $51.32 share with high volume. Look for volume on that move that hits near or above its three-month average action of 1.17 million shares. If that breakout hits post-earnings, then RMD will set up to re-fill some of its previous gap-down-day zone from October of 2013 that started just above $56 a share. If that gap gets filled with strong upside volume flows, then RMD could easily trend north of $60 a share.

 

I would simply avoid RMD or look for short-biased trades if after earnings it fails to trigger that breakout and then drops back below its 50-day moving average of $44.87 a share with high volume. If we get that move, then RMD will set up to re-test or possibly take out its next major support levels at $43 to $41.29 a share. Any high-volume move below those levels will then give RMD a chance to re-test its next major support level at $37.22 a share.

 

Quest Diagnostics

 

My final earnings short-squeeze play is diagnostic testing, information and services provider Quest Diagnostics (DGX), which is set to release numbers on Thursday before the market open. Wall Street analysts, on average, expect Quest Diagnostics to report revenue of $1.75 billion on earnings of 89 cents per share.

 

The current short interest as a percentage of the float for Quest Diagnostics is extremely high at 17.3%. That means that out of the 143.70 million shares in the tradable float, 24.80 million shares are sold short by the bears. If the bulls get the earnings news they're looking for, then shares of DGX could easily rip sharply higher post-earnings as the bears rush to cover some of their bets.

 

From a technical perspective, DGX is currently trending above both its 50-day and 200-day moving averages, which is bullish. This stock has been consolidating and trending sideways for the last month, with shares moving between $57 on the downside and $61.15 on the upside. Any high-volume move above the upper-end of that sideways trading chart pattern post-earnings will triggering a big breakout trade for shares of DGX.

 

If you're in the bull camp on DGX, then I would wait until after its report and look for long-biased trades if this stock manages to break out above some near-term overhead resistance levels at $60.76 to $61.15 a share with high volume. Look for volume on that move that hits near or above its three-month average volume of 2.55 million shares. If that breakout hits, then DGX will set up to re-test or possibly take out its 52-week high at $64.10 a share. Any high-volume move above that level will then give DGX a chance to tag $70 to $75 a share.

 

I would avoid DGX or look for short-biased trades if after earnings it fails to trigger that breakout, and then drops back below both its 200-day at $57.17 to its 50-day at $55.26 a share with high volume. If we get that move, then DGX will set up to re-test or possibly take out its next major support levels at $53 to $50 a share.

 

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

 

-- Written by Roberto Pedone in Delafield, Wis.

 

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

 

Roberto Pedone, based out of Delafield, Wis., is an independent trader who focuses on technical analysis for small- and large-cap stocks, options, futures, commodities and currencies. Roberto studied international business at the Milwaukee School of Engineering, and he spent a year overseas studying business in Lubeck, Germany. His work has appeared on financial outlets including CNBC.com and Forbes.com.

 

You can follow Pedone on Twitter at www.twitter.com/zerosum24 or @zerosum24.