Stock Quotes in this Article: AZO, DSW, FDO, PETM, QIHU

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 timeframe 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.

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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.

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, and then jump in and trade the prevailing trend on a heavily-shorted stock that’s reporting its numbers.

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

DSW

My first earnings short-squeeze play today is specialty retailer player DSW (DSW), which is set to release its numbers on Tuesday before the market open. This company, together with its subsidiaries, operates as a branded footwear and accessories specialty retailer in the U.S. Wall Street analysts, on average, expect DSW to report revenue of $548.09 million on earnings of 90 cents per share.

During the last quarter, DSW beat Wall Street estimates by 2 cents, coming in at a profit of 51 cents a share vs. the estimate of 49 cents per share. That registered the fourth straight quarter of beating Wall Street estimates.

The current short interest as a percentage of the float for DSW is notable at 5.1%. That means that out of the 29.20 million shares in the tradable float, 1.64 million shares are sold short by the bears. The bears have also been increasing their bets from the last reporting period by 8.5%, or by about 128,600 shares.

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From a technical perspective, DSW is currently trading above its 200-day moving average and below its 50-day moving average, which is neutral trendwise. This stock sold off hard from its February high of $42.94 to its recent low of $32.45 a share. During the last three months, this stock has been trending sideways between $51.84 on the downside and $58.65 on the upside. A move outside of that range post-earnings will likely set this stock up for its next major trend.

If you’re bullish on DSW, I would wait until after its report and look for long-biased trades if this stock can manage to move back above its 50-day moving average of $55.42 share with high-volume. Look for volume on that move that registers near or above its three-month average action of 472,787 shares. If we get that action, then I would add to any DSW long positions once it takes out its 52-week high of $58.65 a share with high-volume.

I would simply avoid DSW or look for short-biased trades if after earnings this stock fails to trade back above its 50-day moving average at $55.42, and then drops back below some near-term support at $53.83 to $51.84 a share with heavy volume. If we get that action, look for DSW to re-test its 200-day moving average of $49.41 a share, or possibly trend even lower towards some previous support at $45.50 a share.

PetSmart

Another potential earnings short-squeeze trade idea is PetSmart (PETM), which is set to report results on Tuesday after the market close. This company is a specialty provider of products, services and solutions for the lifetime needs of pets. Wall Street analysts, on average, expect PetSmart to report revenue of $1.60 billion on earnings of 73 cents per share.

Last quarter, PetSmart beat estimates by one cent, coming in at a profit of 91 cents a share versus the estimate of 90 cents per share. This marked the fourth straight quarter of beating Wall Street estimates. This company is hoping to register its fourth straight quarter of income increases when it reports this week. Net income jumped 26.4% in the second quarter or the last fiscal year and 23.1% in the third quarter of the last fiscal year.

The current short interest as a percentage of the float for PetSmart stands at 3.6%. That means that out of the 101.80 million shares in the tradable float, 3.88 million shares are sold short by the bears. This isn’t a huge short interest, but it’s more than enough to spark a sizeable short-squeeze if PetSmart can manage to beat earnings and raise forward guidance.

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From a technical perspective, PETM is currently trading below its 50-day moving average and above its 200-day moving average, which is neutral trendwise. This stock has been uptrending strong for the past six months, with shares soaring from a low of $45.16 to a recent high of $59.36 a share. This stock has recently slipped back below its 50-day moving average of $57.08 a share on heavy volume.

If you’re bullish on PETM, I would wait until after it releases earnings and target long-biased trades if this stock can manage to move back above its 50-day moving average of $57.08 a share with high volume. Look for volume on that move that’s close to or well above its three-month average volume of 980,090 shares. If we get that action, then I would look to add to any long positions if PETM can manage to print a new 52-week high above $59.36 a share with high-volume.

I would simply avoid PETM or look for short-biased trades if after earnings PETM fails to get back above its 50-day, and then drops below some near-term support at $54.07 to $53.17 a share with high-volume. If we get that action, then PETM could easily drop back towards its 200-day moving average of $50.17 a share if the bears hammer this stock down post-earnings.

AutoZone

Another potential earnings short-squeeze play is AutoZone (AZO), which is set to release numbers on Tuesday before the market open. This company is a retailer and distributor of automotive replacement parts and accessories. Wall Street analysts, on average, expect AutoZone to report revenue of $2.13 billion on earnings of $6.25 per share.

On last Friday, analysts at Credit Suisse upgraded shares of AutoZone from neutral to outperform and slapped a $440 price target on the stock. They noted that the move was a valuation call. AutZone currently trades at reasonable valuation, with a trailing price-to-earnings of 17.38 and a forward price-to-earnings of 13.79.

The current short interest as a percentage of the float for AutoZone sits at 4.1%. That means that out of the 26.87 million shares in the tradable float, 1.54 million shares are sold short by the bears. The bears have also been increasing their bets from the last reporting period by 12%, or by about 165,000 shares.

From a technical perspective, AZO is currently trading below its 50-day moving average, and above its 200-day moving average, which is neutral trendwise. This stock has been uptrending strong for the last six months, with shares exploding higher from a low of $313.11 to a recent high of $399.10 a share. During that uptrend, this stock has consistently made higher lows and higher highs, which is bullish technical price action. That said, shares of AZO have recently moved back below its 50-day moving average of $381.68 a share on heavy volume.

If you’re in the bull camp on AZO, then I would wait until after they report and look for long-biased trades if this stock can manage to move back above its 50-day moving average of $381.68 a share with high volume. Look for volume on that move that registers close to or above its three-month average action of 419,224 shares. If we get that action, then I would add to any long positions in AZO if it takes out some near-term overhead resistance at $389.89 a share with volume and target a possible re-test of its 52-week high of $399.10 a share.

I would avoid AZO or look for short-biased trades if the stock fails to recapture its 50-day moving average, and then drops below that major near-term support at $362.66 a share with high-volume. If we get that action, then look for AZO to re-test its 200-day moving average of $343.34 a share, or possibly drop towards some previous support at $330 a share.

AutuZone, one of Lone Pine Capital's holdings, was also featured recently in "5 Cheap, Low-Risk Stocks to Buy."

Family Dollar Stores

One earnings short-squeeze candidate is Family Dollar Stores (FDO), which is set to release numbers on Wednesday before the market open. This company operates a chain of self-service retail discount stores primarily for low- and middle-income consumers in the U.S. Wall Street analysts, on average, expect Family Dollar Stores to report revenue of $2.37 billion on earnings of $1.06 per share.

If you’re looking for strong trending large-cap stock that’s trading within range of its 52-week high heading into earnings, then make sure to check out shares of Family Dollar Stores. This stock is up over 12% so far in 2012, and its currently trading just 5 points off its 52-week high of $70 a share.

The current short interest as a percentage of the float for Family Dollar Stores stands at 3%. That means that out of the 96.40 million shares in the tradable float, 3.33 million are sold short by the bears. This isn’t a huge short interest, but if Family Dollar Stores can deliver what the bulls are looking for, then it could easily see a decent short-covering rally post-earnings.

From a technical perspective, FDO is currently trading above both its 50-day and 200-day moving averages, which is bullish. During the last three months, this stock has soared from a low of $53.06 to its high of $70 a share. That move triggered a major breakout trade once FO took out $59.60 a share with monster upside volume. That said, shares of FDO have struggled during the last month to take out some near-term overhead resistance at around $68.50 to $70 a share.

If you’re bullish on FDO, I would look for long-biased trades if after it reports this stock manages to break out above some near-term overhead resistance at $67 a share high-volume. Look for volume on that move that registers near or well above its three-month average action of 1.6 million shares. If we get that action, then I would add to any long positions on FDO if it can manage to clear its 52-week high of $70 a share with high-volume.

I would simply avoid FDO or look for short-biased trades if the stock fails to trigger that move over $67, and then drops back below some near-term support at its 50-day moving average of $63.80 and at $62.54 a share with high-volume. If we get that action, then look for FDO to possibly fall towards $60 to $58 a share if the bears spark a big-time selloff post-earnings.

As of the most recently reported quarter, Family Dollar was one of Third Point's holdings and showed up in Bill Ackman's portfolio.

Qihoo 360 Technology

My final earnings short-squeeze idea for today is computer services player Qihoo 360 Technology (QIHU), which is set to release numbers on Tuesday after the market close. This company is engaged in the operations of Internet services and sales of third party anti-virus software in the People's Republic of China. Wall Street analysts, on average, expect Qihoo 360 Technology to report revenue of $60.47 million on earnings of 17 cents per share.

The current short interest as a percentage of the float for Qihoo 360 Technology is extremely high at 22.1%. That means that out of the 44.19 million shares in the tradable float, 13.05 million are sold short by the bears. This is a very high short interest on a stock with a relatively low tradable float. If Qihoo 360 Technology can report a solid quarter and raise its forward guidance, then this stock could skyrocket post-earnings.

From a technical perspective, QIHU is currently trading right below its 50-day moving average and above its 200-day moving average, which is neutral trendwise. This stock has been uptrending strong for the past five months, with shares moving sharply higher from a low of $13.71 to a high of $26.35 a share. After hitting that high, shares of QIHU have struggled to get above $26.30 to $25 a share, with sellers coming in to drive the stock lower whenever it trades near those levels. Shares of QIHU recently moved back below its 50-day moving average of $22.19 with high volume.

If you’re in the bull camp on QIHU, I would wait until after its report and look for long-biased trades if this stock manages to trade above some near-term overhead resistance at $21.72, and its 50-day moving average of $22.91 a share with high-volume. Look for volume on that move that’s near or well above its three-month average action of 2,093,890 shares. If we get that move, then QIHU has a good chance to re-test that significant overhead resistance at $25 to $26.30 a share if the bulls gain full control of this stock post-earnings.

I would simply avoid QIHU or look for short-biased trades if it fails to trigger that move over $21.72 to $22.91 a share, and then drops below some major near-term support levels at its 200-day moving average of $19.71 to $18.80 a share with high-volume. If we get that action, then I would target a drop back towards $16 to $15 a share or possibly lower if the bears hammer this stock down post-earnings.

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.