Stock Quotes in this Article: CMG, FFIV, INFN, ISRG, VMW

WINDERMERE, Fla. (Stockpickr) -- News events have the power to create massive volatility in the market, and the one event that can move stocks 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 you have the fuel that can ignite a large short squeeze in any stock.

Short-sellers hate being caught short a stock that produces earnings that please the bulls on Wall Street. When this happens, we often see tradable short squeezes develop as the bears 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 need to find just 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 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 from off a short squeeze. When you do this, you let 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 by waiting 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.

    Intuitive Surgical

    My first earnings short-squeeze candidate is Intuitive Surgical (ISRG), which is set to report its results on Tuesday after the market close. This company designs, manufactures, and markets da Vinci surgical systems for various surgical procedures, including urologic, gynecologic, cardiothoracic, general and head and neck surgeries. Wall Street analysts, on average, expect Intuitive to report revenue of $410.35 million on earnings of $2.71 per share.

    This is currently my favorite earnings short-squeeze play because Intuitive Surgical has a strong history of earnings beats that send its stock soaring. The company has beaten estimates for the last four quarters in a row. During the previous quarter, Intuitive reported earnings per share of $2.59, beating analysts’ estimates of $2.49. Intuitive has also racked up double-digit year-over-year percentage revenue growth for the past four quarters. The average growth during that timeframe has been 24%

    The current short interest as a percentage of the float for Intuitive Surgical stands at 4.4%. That means that out of the 38.78 million shares in the tradable float, 1.72 million are sold short by the bears. This isn’t a huge short interest, but it’s enough to spark a decent short squeeze rally if Intuitive Surgical delivers what the bulls are looking for.

    From a technical standpoint, shares of ISRG have recently bounced around 10 points to the upside off of its 50-day moving average of $353.69 a share. The stock is now trading around 15 points off of its 52-week high of $384.49 a share.

    If you want to play ISRG for an earnings short squeeze play, I would either buy some call options ahead of the quarter, or I would wait until after they report and buy the stock once it trades above the 52-week high of $384.49. Look for confirmation of a sustained breakout above that level if you see volume that clocks in above ISRG’s three-month average volume of 309,000 shares.

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    VMware

    Another potential earnings short squeeze trade is VMware (VMW), which is set to report results on Tuesday after the market close. This is a provider of virtualization solutions from the desktop to the data center. Wall Street analysts, on average, expect VMware to report revenue of $872.96 million on earnings of 47 cents per share.

    This company has a solid track record of beating bottom-line estimates, since they have topped that benchmark for the past four quarters in a row. VMware has also seen its net income rise in three straight quarters, with the first-quarter showing a jump in net income of 60.4%.

    It’s also worth pointing out that IBM (IBM) reported a solid quarter on Monday, which could bode well for VMware since it operates in some of the same segments. What I like most about the IBM quarter was that the company raised guidance. This could mean that spending is picking up across the board in the tech sector, which should be bullish for a big tech player such as VMware.

    The current short interest as a percentage of the float for VMware is 5.3 %. That means that out of the 78.27 billion shares in the tradable float, 4.15 million are sold short by the bears. It’s worth noting that the short-sellers have been increasing their bets from the last reporting period by 26.4%, or about 866,000 shares. That’s a big increase, so if VMware delvers solid results and bullish guidance, the stock could see a big short-covering rally.

    From a technical standpoint, VMW is just a few points off of a major breakout if the stock can manage to trade above some past overhead resistance at $105.47 a share. The stock has started to make a run at that key breakout levels, after it found some solid buying support at close to $100 a share.

    The way I would play VMW is to wait for it to report and then buy the stock if you see it break out above $105.47 a share on heavy volume. Look for volume that’s greater than or close to the three-month average action of 2.3 million shares. I would only short this stock after VMW reports if the stock trades below $100 to $99.52 a share on heavy volume.

    VMware, one of TheStreet Ratings' top-rated software stocks, was highlighted last month in "5 Stocks Worth Buying in This Shaky Market."

    Chipotle Mexican Grill

    An earnings short-squeeze play in the casual restaurant sector is Chipotle Mexican Grill (CMG), which is set to release numbers on Tuesday after the market close. This company develops and operates fast-casual, fresh Mexican food restaurants in the U.S. It also operates restaurants in Toronto, Canada and in London, the United Kingdom. Wall Street analysts, on average, expect Chipotle to report revenue of $558.34 million on earnings of $1.68 per share.

    Chipotle is trading very strong heading into the quarter, with shares only a few points off of their 52-week high. There are some analysts on the street that have concerns that CMG could get hit this quarter due to higher food costs, especially with beef. That said, due to its affordable menu and this continued low job growth economy, the company could easily offset higher food costs with soaring sales.

    The current short interest as a percentage of the float for CMG sits at around 11.5%. That means that out of the 30.59 million shares in the tradable float, 3.52 million are sold short by the bears. This is a high enough short interest for a stock with a very low float. This type of situation can produce big short squeezes post a positive earnings report. It’s also worth pointing out that the short-sellers have been increasing their bets from the last reporting period by 9.8%, or by about 314,000 shares.

    From a technical standpoint, shares of CMG hit an all-time high today at $332.95 a share. You just can’t fight strength like this in a stock trading right in front of a big earnings report. This stock is literally breaking out right in front of the quarter.

    The way I would play this stock is very simple since it's coming right out of a basing chart pattern between $320 and $328 a share. Wait until after CMG reports and buy the stock as long as it holds above $328 and takes out that $332.44 all-time high. Look for a strong volume move above $332.44 to confirm it wants to go much higher. The three-month average volume is 993,000 shares, so key off that number.

    One could also buy some call options ahead of the report you want to speculate. I would only short CMG if it trades below $328 on strong volume following their earnings report. Remember, this stock has moved big in the past on earnings, so be prepared to trade it either way.

    Chipotle, one of Jim Cramer's FADS CAN stocks, was featured recently in "5 Breakout Trades for July Profits" as well as "5 Earnings Stocks to Be Wary Of."

    Infinera

    One earnings short-squeeze play in the communications services sector is Infinera (INFN), which is set to release numbers on Tuesday after the market close. Infinera is a provider of optical networking systems based on photonic integration technology. Wall Street analysts, on average, expect Infinera to report revenue of $94.49 million on a loss of 11 cents per share.

    I like this name heading into the quarter as a beaten-down earning short-squeeze play. In just the last six months, shares of INFN have fallen from a yearly high of $11.15 to its current price of around $6.33 a share. This could be setting the stock up for a sharp rebound if Infinera can report a decent quarter.

    The current short interest as a percentage of the float for Infinera is notable at 7.7%. That means that out of the 100.67 million shares in the tradable float, 7.38 million are sold short by the bears.

    From a technical standpoint, INFN is currently trading below both its 50-day and 200-day moving averages, which is bearish. That said, the stock has recently found some buying support at around $5.90 a share and is holding above that level heading into the quarter.

    The way I would play INFN is to buy the stock after the quarter if the stock holds above $5.90 a share and also breaks above its 50-day moving average of $6.80 a share on big volume. Look for volume that’s better than the three-month average action of around 1 million shares. I would only short this stock if it trades below $5.90 on heavy volume after the quarter.

    Infinera shows up in the portfolio of Wilbur Ross' Invesco Private Capital.

    F5 Networks

    One more earnings short-squeeze play is F5 Networks (FFIV), which is set to release numbers on Wednesday after the market close. This is a provider of technology that optimizes the delivery of network-based applications and the security, performance and availability of servers, data storage devices and other network resources. Wall Street analysts, on average, expect F5 Networks to report revenue of $290.66 million on earnings of 91 cents per share.

    This company has topped estimates the last four quarters in a row and is coming off a quarter in which it beat estimates by 1 cent, posting a profit of 68 cents per share vs. estimates for 67 cents per share. The last time F5 reported, the stock popped big as the shorts ran to cover their bearish bets. The stock jumped from around $92 to a high of $111.63 the following day. This demonstrates that FFIV can move big following earnings.

    The current short interest as a percentage of the float for F5 is a reasonable 4.8%. That means that out of the 80.65 million shares in the tradable float, 3.88 million are sold short by the bears.

    From a technical standpoint, shares of FFIV have recently bounced nicely off of its 50-day moving average and off its 200-day moving average. The stock is now quickly approaching a major breakout level at $119.69 a share, with the stock trading around $117 a share.

    I would be a buyer of this stock following the report once it takes out $119.69 a share on strong volume that’s greater than its three-month average daily volume of 2.5 million shares. I would add to any long positions above $122 and look for a test of some big overhead resistance at $129 a share. I would only short this name if it trades below the 200-day ($113.57) on big volume following the report. You could add to any short bets below $110 a share.

    F5, another of Cramer's FADS CAN stocks, is one of TheStreet Ratings' top-rated communications equipment stocks.

    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.