Stock Quotes in this Article: AVAV, FINL, LZB, MU, SONC

 WINDERMERE, Fla. (Stockpickr) -- News events have the power to create massive volatility in the stock market, and one event that can move a stock substantially higher or lower is an earnings release. Take that one step further and combine a bullish earnings report with a stock that’s heavily shorted, and all of a sudden you have the fuel that can ignite a large short squeeze.

Short-sellers hate being caught short a stock that produces earnings that please the bulls on Wall Street. When this happen, we often see tradable short squeezes develop as the bear rush to cover their positions and avoid even bigger losses. Even the best short-sellers know that it’s never a good idea to stay short once a big short-covering rally starts that’s sparked by an earnings event.

This is precisely why I search the market for heavily shorted stocks that are about to report earnings. You only need to find a couple of these candidates in a year to help enhance your portfolio returns -- the gains become so outsized in such a short timeframe that your profits add up quickly.

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    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 manage your risk accordingly. Sometimes the best play is to wait for the stock to breakout following the report before you jump in to profit from off a short squeeze. When you do this you’re letting the trend emerge after the market has digested all of the news.

    However, sometimes the stock is going to be in such high demand that you will miss a lot of the move. That’s why it’s only worth betting prior to the report if you have a very strong conviction that the stock is going to explode higher.

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

    AeroVironment

    My first earnings short-squeeze candidate is AeroVironment (AVAV), which is set to report its results on Tuesday after the market close. This company designs, develops, produces and supports unmanned aircraft systems and efficient energy systems for various industries and governmental agencies. Wall Street analysts, on average, expect AeroVironment to report revenue of $99.16 million on earnings of 69 cents per share.

    This company did well last quarter after it reported earnings of 52 cents a share, easily beating Wall Street estimates for 38 cents a share. We could be setting up for a similar big beat this quarter, but caution is also warranted since government budget cuts might have slowed sales at this defense contractor. EarlyBird Capital recently said that AVAV is in the right place at the right time, and they believe the current share price does not reflect strong growth prospects at the company. EarlyBird also has a buy rating on the stock and a $35 price target.

    The current short interest as a percentage of the float for AVAV stands at 9.6%. That means that out of the 17.89 million shares in the tradable float, 1.67 million are sold short by the bears. The short-sellers have been increasing their bets from the last reporting period by 3.4%, or by about 55,062 shares. This stock has an extremely low float and decent short interest, so any good news could spike this higher after earnings.

    From a technical standpoint, AVAV has been hit very hard since April with the stock dropping from $36 a share to its current price of around $28. This deep selloff could be setting it up for a sharp rebound if the company can report solid numbers. The stock is now trading right around a big support zone that dates back to the start of the year, at around $26 to $27 a share.

    One could buy the stock following earnings if that support zone holds, and you see shares take out the 50-day moving average of $28.86 with volume. Look for volume that’s well above the three-month average activity of 242,000 shares. Any break below $26 a share would get me short AVAV or at the least cause me to avoid the stock as an earnings short-squeeze play.

    Sonic

    Another potential earnings short squeeze play is Sonic (SONC), which is set to report results on Wednesday after the market close. This company operates and franchises a chain of drive-in restaurants, Sonic Drive-Ins, in the U.S. Wall Street analysts, on average, expect Sonic to report revenue of $150.53 million on earnings of 18 cents per share.

    Last quarter Sonic failed to beat analysts’ estimates, but now that we’re moving into the summer season, this drive-in play should be seeing a pickup in business. The only unknown here is whether higher gas prices have kept customers away. I doubt this was an issue since Sonic offers a low-priced menu combined with an attractive drive-in theme experience.

    The current short interest as a percentage of the float for SONC is a notable 10.2%. That means that out of the 58.23 million shares in the tradable float, 5.51 million are sold short by the bears. This is a reasonably low float with a decent short interest at SONC. If the company reports good news, the stock could see a nice pop to the upside.

    From a technical analysis, the stock has recently bounced off of its 200-day moving average of $9.58 a share. Now the stock is trading right around its 50-day moving average of $10.57 a share. My game plan here is to wait until after earnings and buy some shares if you see it break above its recent near-term high of $11.05. A move above this level would break a pattern of lower highs that the stock has been printing for the past two months. I would add aggressively to any position if you see the stock take out its 52-week high of $11.86 a share.

    Avoid this stock completely or short it if you see shares trend below the 50-day moving average with volume following their report. The three-month average volume on SONC is 886,000 shares.

    >>Practice your stock trading strategies and win cash in our stock game.

    Micron Technology

    One heavily shorted stock that could be setting up for a big earnings short squeeze is Micron Technology (MU), which is set to release numbers on Thursday after the market close. This company, together with its subsidiaries, engages in the manufacture and marketing of semiconductor devices worldwide. Wall Street analysts, on average, expect Micron to report revenue of $2.37 billion on earnings of 16 cents per share.

    Morgan Stanley recently said in a note to clients that it expects Micron to report in-line to better results due to better memory pricing data through May with impact from higher DRAM costs. If this hold s true, and Micron issues bullish guidance, then the stock could easily pop off of depressed levels.

    The current short interest as a percentage of the float for MU is 5.9%. That means that out of the 974.70 million shares in the tradable float, 57.27 million are sold short by the bears. The shorts have also been increasing their bets from the last reporting period by a very large 20%, or by about 9.6 million shares. That’s a huge increase, so if MU reports anything good we could see a situation where the shorts run to cover some of those bets.

    From a technical standpoint, this stock has been whacked huge from its recent high of $11.83 to its current price of $7.91 a share. What’s even more important on Micron here is that the stock has traded down right into some longer-term support at $7.65 a share. So far, that level has held and what happens post-earnings will define the trade. My game plan here is to wait until after earnings and see if the stock holds $7.64. If it does, I would jump in and go long the stock for a potential short squeeze play. If it doesn’t hold, avoid this or short shares and look for lower prices.

    Micron is one of the top holdings of David Tepper's Appaloosa Management, as of the most recently reported period.

    La-Z-Boy

    Another heavily shorted stock into earnings is La-Z-Boy (LZB), which is set to release numbers on Tuesday after the market close. This company manufactures, markets, imports, distributes and retails upholstery products and wood case goods furniture products under the La-Z-Boy name in the U.S. and Canada. Wall Street analysts, on average, expect La-Z-Boy to report revenue of $325.45 billion on earnings of 19 cents per share.

    Last quarter, the company beat estimates by 2 cents a share, and the stock soared 18%. I think even a modest rebound off of depressed levels for furniture sales could boost numbers for this quarter and send the stock up sharply again. It’s true that the housing sector is still in disarray, but the rental market remains strong and as consumers hold off on home purchases, they in turn have more disposable cash to spend on furniture upgrades.

    The current short interest as a percentage of the float for LZB is 10.2%. That means that out of the 45.77 million shares in the tradable float, 5.06 million are sold short by the bears. This is another reasonably low-float and high-short-interest situation that could lead to a spike higher if LZB can report solid numbers and bullish guidance.

    From a technical standpoint, shares of LZB recently bounced hard off the 200-day moving average. The stock is now trading right below its 50-day moving average of $10.66 a share. I would look to buy this stock post-earnings or before if you see this stock move above the 50-day on strong volume. Look for volume that’s well above the three-month average action of 640,000 shares.

    One could also wait for the stock to breakout post-earnings and buy off a strong volume move above $11.16 to $11.84 a share. If those levels get taken out, we could see a quick run up towards the next significant overhead resistance levels at $12.84 to $13.33 a share.

    Finish Line

    One more stock that could see an earnings inspired short squeeze is Finish Line (FINL), which is set to release numbers on Thursday after the market close. This company, together with its subsidiaries, operates as a mall-based specialty retailer in the U.S. It operates Finish Line stores that offer performance and athletic casual footwear, apparel, and accessories for men, women and kids. Wall Street analysts, on average, expect Finish Line to report revenue of $300.81 million on earnings of 30 cents per share.

    An analyst from Sterne Agee said in a note to clients on Monday that FINL is poised for a positive first-quarter report due to strong demand for athletic footwear. Agee cited the running business which continues to improve as a catalyst that could boost the stock. High-end running shoes are a specialty at Finish Line.

    The current short interest as a percentage of the float for FINL is 10.2%. That means that out of the 51.35 million shares in the tradable float, 5.33 million are sold short by the bears. This is another low float reasonable short interest situation. What’s even better here is that FINL has held up strong during the recent market selloff.

    From a technical standpoint, shares of Finish Line are trading very close to a major breakout if the stock can manage to trade above some past overhead resistance at $23.27 a share. A move above that level would mark a brand new 52-week high and multi-year high for this stock. With that in mind, the only way I would trade this is to buy the breakout post-earnings if we get it on strong volume. Look for a high-volume move that’s well above three-month average of 775,000 shares.

    Avoid this trade completely if that doesn’t happen, and I would only consider getting short if it fails to break out and you see a move below the 50-day moving average of $21.66 with strong volume. The trend in the stock tells me the probability for the breakout is higher, so that would be my focus going into the quarter.

    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.