Stock Quotes in this Article: AMD, CAKE, CPHD, HGSI, TZOO

 WINDERMERE, Fla. (Stockpickr) -- With earnings season in full swing on Wall Street, it's the perfect opportunity for market-players = to create a = watchlist of stocks due to report numbers that are also heavily shorted by the bears.

Nothing will frustrate a short-seller more than being caught short a stock that produces a positive earnings report. When this happens, we often see tradable short squeezes develop as the bears rush to cover their positions to avoid big 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 a positive earnings report.

This is exactly why I search the market for heavily shorted stocks that are about to report earnings. You only need to find just 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.

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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 breakout 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 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 rip higher.

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

     

    Advanced Micro Devices

    My first earnings short-squeeze candidate is global semiconductor player Advanced Micro Devices (AMD), which is set to report its results on Thursday after the market close. Wall Street analysts, on average, expect Advanced Micro Devices to report revenue of $1.58 billion on earnings of 8 cents per share.

    Analysts’ are expecting weaker sales from AMD due to depressed PC market that is running behind the usual seasonal patterns. Gartner recently said that worldwide PC shipments grew less than 3% versus last year, as consumer have flocked to tablets and smartphones, such as the popular devices made by Apple (AAPL). That said, I can see AMD reporting decent numbers and showing that management is improving its financial model and turning around the firm.

    The current short interest as a percentage of the float for AMD is a very large 14.4%. That means that out of the 579.56 million shares in the tradable float, 83.57 million are sold short by the bears. The short-sellers have also been increasing their bets from the last reporting period by 21.2%, or by about 14.5 million shares. That is a gigantic increase, so if AMD can produce a bullish result this stock could easily short squeeze big.

    From a technical standpoint, shares of AMD are trading below both its 50-day and 200-day moving averages. The stock has been annihilated in the past couple of months, falling from a high of $9.17 a share to its current level of $6.40 a share. The stock has found some recent buying support at close to $6 a share.

    If you want to play AMD for an earnings trade I would suggest waiting until after it reports and only buy the stock if it trades above $6.70 a share on strong volume. I would add to any long position once the stock takes out more overhead resistance at $7.25 a share, and then add again above the 50-day of $7.59 and 200-day of $8. I would only short this stock following the report if it drops below $6a share on strong volume.

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    Travelzoo

    Another potential earnings short squeeze play is global Internet media player Travelzoo (TZOO), which is set to report results on Thursday before the market open. Travelzoo informs over 20 million subscribers worldwide, as well as millions of Web site users, about the best travel and entertainment deals available from thousands of companies. Wall Street analysts, on average, expect Travelzoo to report revenue of $39.85 million on earnings of 38 cents per share.

    This is my favorite earnings short-squeeze play for this article because Travelzoo is so heavily shorted and it has a history of making huge moves off earnings. That said, it has made large moves both ways, so trade this one very carefully. During the last quarter, Travelzoo beat handily, so if that trend continues for this quarter, this stock is going to crush the shorts.

    The current short interest as a percentage of the float for Travelzoo is an extremely large 64%. That means that out of the 5.54 million shares in the tradable float, 3.58 million are sold short by the bears. The short-sellers have been increasing their bets dramatically from the last reporting period by 42.5%, or by about 1 million shares. That’s a gigantic increase, so if the bears are leaning the wrong way into the quarter, then this stock is going to explode higher.

    From a technical standpoint, shares of TZOO are trending very strong into the quarter with the stock recently breaking out above $78 to $79 a share on big volume. This breakout has now out the stock within about 16 points of its all-time high of $103.80 a share.

    The way I play TZOO is to wait for the company to report and buy the stock once it trades above $90.80 a share, which is a recent overhead resistance level. I would only add to this trade if you see TZOO break out above its all-time high of $103.80 a share. I would only short TZOO if the stock drops below $75 a share following its earnings report on heavy volume.

    Human Genome Sciences

    One earnings short-squeeze play in the biotech space is Human Genome Sciences (HGSI), which is set to release numbers on Thursday after the market close. This company’s products are Benlysta (belimumab) for systemic lupus erythematosus (SLE) and raxibacumab for inhalation anthrax. Wall Street analysts, on average, expect Human Genome Sciences to report revenue of $29.03 million on a loss of 41 cents per share.

    This stock has been beaten-down big ahead of their earnings report, with shares falling from a recent high of $30 a share to its current price at around $23.50 a share. This large beat-down on the stock could be setting up HGSI for an earnings short squeeze rebound if the company can deliver solid results.

    Keep in mind that any positive news about HGSI’s newly approved lupus drug Benlysta could send this stock soaring, since the drug has major blockbuster potential. Investors will be keying off of prescription data and sales figures, so anything that comes in ahead of analysts’ estimates could really move this stock.

    The current short interest as a percentage of the float for HGSI sits at around 9.1%. That means that out of the 189.04 million shares in the tradable float, 17.22 million are sold short by the bears.

    From a technical standpoint, shares of HGSI are trading below both its 50-day and 200-day moving averages, which is bearish. That said, the stock recently found some buying support at around $22.30 and the relative strength index is coming off of a 30 reading, which is a very oversold level on any stock.

    The way I would play this stock is to wait for the company to report earnings and then buy the stock if it trades above $24.50 a share on solid volume. I would add to any long positions if HGSI moves above its 200-day moving average of $26.05 a share. I would only short this stock if it drops below $22.30 a share on strong volume.

    Human Genome shows up on a recent list of 5 Biotech Drug-Launch Stocks to Watch.

    Cheesecake Factory

    One earnings short squeeze play in the casual restaurant sector is Cheesecake Factory (CAKE), which is set to release numbers on Wednesday after the market close. This company operates upscale, casual and full-service dining restaurants in the U.S. Wall Street analysts, on average, expect Cheesecake Factory to report revenue of $434.76 million on earnings of 42 cents per share.

     

    This company has beaten analysts’ expectations for four quarters in a row. Their revenue has increased for three straight quarters and gross margins have also been trending up. Lower gas prices moving into the end of current quarter could have helped Cheesecake Factory win more sales, and potential beat estimates.

    The current short interest as a percentage of the float for CAKE is a rather large 16.8%. That means that out of the 53.66 million shares in the tradable float, 9.02 million are sold short by the bears. This is a very large short position on a stock with a low float. As I have mentioned in many earnings short squeeze articles, this is the type of setup that can produce a massive short-covering rally if the bulls get the news they’re looking for.

    From a technical standpoint, shares of CAKE are entering this earnings report with the stock stuck in range between $34 on the upper end and $32 on the lower end. This will make the stock pretty easy to play since a break either way should define the next trend for CAKE.

    The way I would play CAKE is to buy this stock if it breaks out above $34.07 on strong volume following the earnings report. A move above that level would trigger a major breakout, so if it comes off of a strong earnings report, it could be even more powerful. I would only short this stock after they report if shares fall below $32.20 on big volume. I would add to any short position if it breaks below its 50-day moving average of $31.30 a share.

    Cepheid

    One final earnings short squeeze play is Cepheid (CPHD), which is set to release numbers on Thursday after the market close. This is a molecular diagnostics company that develops, manufactures and markets integrated systems for testing in the clinical market, as well as for application in its legacy biothreat, industrial and partner markets. Wall Street analysts, on average, expect Cepheid to report revenue of $60.96 million on a loss of 2 cents per share.

    This stock has just been downgraded by Goldman Sachs heading into its report. The Goldman analyst thinks the stock offers fewer potential rewards at current levels since shares have returned over 56% so far in 2011.

    The current short interest as a percentage of the float for CPHD is a notable 12.7%. That means that out of the 60.38 million shares in the tradable float, 7.69 million are sold short by the bears. This is more than enough shorts to spark a short-covering rally if CPHD can produce strong earnings results.

    From a technical standpoint, shares of CPHD have recently dropped from a high of $35.70 to its current price of close to $31 a share. This drop has moved the stock below its 50-day moving average of $32.05 a share, and volume during this slide has been heavier than normal.

    I would be a buyer of this stock following the report once if it makes a strong volume move back above its 50-day moving average, and if it trades above some near-term overhead resistance at $33.27 a share. Only add to any long position if it takes out $35.70 on the upside. I would only short this stock if it falls below some near-term support at $30.50 on strong volume. A move below that level could setup CPHD to test its 200-day moving average at $26.30 a share.

    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.