Stock Quotes in this Article: DRI, JEF, KBH, KMX, RAD

WINDERMERE, Fla. (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.

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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 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. That’s why it can be worth betting prior to the report -- but only if you have a very strong conviction that the stock is going to rip higher, and its acting technically very bullish. Remember, even when you have that conviction and you 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.

Rite Aid

My first earnings short-squeeze trade idea today is retail drugstore player Rite Aid (RAD), which is set to report results on Thursday before the market open. Wall Street analysts, on average, expect Rite Aid to report revenue of $6.21 billion on a loss of 7 cents per share.

During the last quarter, this company reported a net income of 1 cent per share vs. Wall Street estimates of a net loss of 4 cents per share, beating estimates after missing them in the previous quarter. During the fourth quarter of the last fiscal year, Rite Aid missed Wall Street estimates by 5 cents per share.

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The current short interest as a percentage of the float for Rite Aid sits at 5.8%. That means that out of the 698.90 million shares in the tradable float, 41.30 million are sold short by the bears. This isn’t a huge short interest, but it’s more than enough to spark a short-covering rally post-earnings if Rite Aid can deliver bullish earnings news.

From a technical perspective, RAD is currently trading above its 50-day moving average and below its 200-day moving average, which is neutral trendwise. This stock has been uptrending decent from its April low of $1.05 to its recent high of $1.35 a share. During that uptrend, shares of RAD have been mostly making higher lows and higher highs, which is bullish technical price action. That move has now pushed RAD within range of triggering a near-term breakout trade post-earnings.

If you’re bullish on RAD, then I would wait until after its report and look for long-biased trades if this stock can manage to break out above some near-term overhead resistance levels at $1.35 to $1.46 a share with high volume. Look for volume on that move that registers near or above its three-month average volume of 913,107 shares. If that breakout triggers, then look for RAD to possibly hit $1.63 to $1.90 a share post-earnings.

Jefferies Group

Another earnings short-squeeze play is securities and investment banking firmJefferies Group (JEF), which is set to release its numbers on Thursday before the market open. Wall Street analysts, on average, expect Jefferies Group to report revenue of $367.17 million on earnings of 19 cents per share.

This stock has been trending modestly bullish so far in 2012, with shares up over 12%. S&P Capital IQ recently downgraded shares of Jefferies Group to hold from buy, citing weakening capital markets for equity and fixed income trading.

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The current short interest as a percentage of the float for Jefferies Group is notable at 3.7%. That means that out of the 204.01 million shares in the tradable float, 6.79 million shares are sold short by the bears. The bears have also been increasing their bets from the last reporting period by 10.5%, or by about 646,000 shares. If the bears are caught leaning too hard into this quarter, then we could easily see a decent short-squeeze setup post-earnings.

From a technical perspective, JEF is currently trading above both its 50-day and 200-day moving averages, which is bullish. This stock has been uptrending very strong since it hit a low in July at around $11.59 a share to its recent high of $16.44 a share. During that uptrend, shares of JEF have consistently made higher lows and higher highs, which is bullish technical price action. That move has now pushed JEF within range of triggering a near-term breakout trade post-earnings.

If you’re in the bull camp on JEF, 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 at $16.44 with high volume. Look for volume on that move that hits near or above its three-month average volume of 1.8 million shares. If we get that breakout, then JEF will have a chance to re-test or possibly take out its next significant overhead resistance level at $19.62 a share. Any move above $19.62 would push JEF into new 52-week high territory, which is bullish technical price action.

I would simply avoid JEF or look for short-biased trades if after earnings this stock fails to trigger that breakout, and then moves back below its 200-day at $14.63 a share with heavy volume. If we get that move, then JEF will setup to re-test and possibly take out its 50-day at $13.59 a share.

KB Home

Another potential earnings short-squeeze trade in the homebuilder KB Home (KBH), which is set to release numbers on Friday before the market open. Wall Street analysts, on average, expect KB Home to report revenue of $430.03 million on a loss of 16 cents per share.

This stock has been on fire so far in 2012, with shares up a whopping 90% so far. That hot start has pushed shares of KB Home very close to its 52-week high of $13.65 a share as we near its earnings report.

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The current short interest as a percentage of the float for KB Home is extremely high at 44.3%. That means that out of the 65.67 million shares in the tradable float, 29.06 million shares are sold short by the bears. This is a gigantic short interest on a stock with a relatively low float. Any bullish earnings news out of KBH could easily setup the stock for a monster short-squeeze.

From a technical perspective, KBH is currently trading above both its 50-day and 200-day moving averages, which is bullish. This stock has been uptrending very strong for the last four months, with shares skyrocketing from a low of $6.44 to a recent high of $13.65 a share. During that uptrend, shares of KBH have consistently made higher lows and higher highs, which is bullish technical price action. That move has now pushed KBH within range of triggering a near-term breakout trade post-earnings.

If you’re bullish on KBH, then I would wait until after its report and look for long-biased trades if this stock can manage to break out above some near-term overhead resistance at $13.65 a share with high volume. Look for volume on that move that tracks in close to or above its three-month average action of 5.5 million shares. If we get that breakout, then look for KBH to re-test or possibly take out its next major overhead resistance level at $15.51 a share. Any high-volume move above $15.51 could put $20 a share into play for KBH.

I would avoid KBH or look for short-biased trades if after earnings it fails to trigger that breakout, and then drops below some near-term support at $12 to $11 a share with heavy volume. If we get that action, then KBH will setup re-test and possibly take out both its 50-day at $10.63 and its 200-day at $9.33 a share post-earnings.

CarMax

A potential earnings short-squeeze trade in the auto dealership complex is used vehicle retailer CarMax (KMX), which is set to release numbers on Thursday before the market open. Wall Street analysts, on average, expect CarMax to report revenue of $2.74 billion on earnings of 52 cents per share.

During the last quarter, CarMax met Wall Street estimates after it reported net income of 52 cents per share. In the previous fourth quarter of the last fiscal year, the company beat Wall Street estimates by one cent. For its top line, this company is looking to register its fourth-straight quarter of revenue increases heading into this earnings call.

The current short interest as a percentage of the float for CarMax is decent at 5.8%. That means that out of the 227.10 million shares in the tradable float, 13.20 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-squeeze if CarMax can please the bulls with its results.

From a technical perspective, KMX is currently trading above both its 50-day and 200-day moving averages, which is bullish. This stock has been uptrending very strong for the last two months and change, with shares soaring from a low of $24.83 to its recent high of $33.83 a share. During that uptrend, shares of KMX have consistently been making higher lows and higher highs, which is bullish technical price action. That move has now pushed KMX within range of triggering a near-term breakout trade post-earnings.

If you’re leaning bullish on KMX, then I would look for long-biased trades after earnings if this stock manages to break out above some near-term overhead resistance at $33.38 a share with high volume. Look for volume on that move that hits near or above its three-month average action of 2 million shares. If that breakout triggers after earnings, then KMX will have a great chance of re-testing or possibly taking out its next major overhead resistance at $35.17 to $37.02 a share. Keep in mind that any move above $35.17 would push KMX into new 52-week-high territory.

I would simply avoid KMX or look for short-biased trades after earnings the stock fails to trigger that breakout, and then moves back below both its 200-day at $30.14 and its 50-day at $29.13 a share with high volume. If we get that move, then KMX will setup to re-test its next major support levels at $27 to $26 a share.

Darden Restaurants

My final earnings short-squeeze play today is Darden Restaurants (DRI), which is set to release numbers on Friday before the market open. This company owns and operates full-service restaurants in the U.S. and Canada under the Red Lobster, Olive Garden, LongHorn Steakhouse and Eddie V's Prime Seafood brand names. Wall Street analysts, on average, expect Darden Restaurants to report revenue of $2.03 billion on earnings of 84 cents per share.

This stock is off to a decent start so far in 2012, with shares up by around 20%. That decent start has moved this stock very close to its 52-week high of $55.84 a share as we move closer to its earnings report.

The current short interest as a percentage of the float for Darden Restaurants is decent at 6.7%. That means that out of the 128.02 million shares in the tradable float, 8.48 shares are sold short by the bears. Any bullish earnings news from DRI should set this stock up for solid short-squeeze post-earnings.

From a technical perspective, DRI is currently trading above both its 50-day and 200-day moving averages, which is bullish. This stock has been uptrending strong for the last three months and change, with shares trending higher from $47.92 to its recent high of $55.13 a share. During that uptrend, shares of DRI have consistently been making higher lows and higher highs, which is bullish technical price action. That move has now pushed RI within range of triggering a near-term breakout trade post-earnings.

If you’re bullish on DRI, then I would wait until after they report and look for long-biased trades if this stock manages to break out above some near-term overhead resistance at $55.13 to $55.30 a share with high volume. Look for volume on that move that registers near or above its three-month average volume of 1.5 million shares. If we get that breakout, then DRI will setup to enter new 52-week high territory. Some possible upside targets are $60 to $65 a share post-earnings.

I would avoid DRI or look for short-biased trades after earnings if it fails to trigger that breakout, and then moves back below its 50-day moving average of $52.30 a share with heavy volume. If we get that move, then DRI will setup to re-test or possibly take out its next major support level at $51.29 a share. Any high-volume move below $51.29 will setup DRI to re-test its 200-day moving average of $49.32 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 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.