A pretty remarkable shift in sentiment happened in the stock
last month and few may have noticed. The short positions among the
most heavily shorted stocks on the stock market shrank by a major
Consider the drop in these short interest positions for stocks
that trade on the New York Stock Exchange…
I can't personally recall seeing such a big two-week drop in
recent memory. What happened? Well, the major averages didn't
move much during those two weeks, so it wasn't a matter of
profit-taking or fears of a
. Frankly, it's a bit of a mystery and it will be interesting
to see the next set of data, scheduled for around July 25 (covering
the period through July 15).
Yet it's noteworthy that the one stock in this table that did
see a rise in the short position was eventually hammered --
fell nearly 50% on July 11 after the company reported a weak fiscal
first quarter and a major restructuring.
This beleaguered supermarket chain has company. Short
sellers have also been targeting chip maker
, which has the 12th-largest short position on the
. The company recently warned of a quarterly shortfall, and
are now down nearly 20% since the month began.
Short sellers also boosted their position in coal maker
Patriot Coal (NYSE:
a hefty 26% in just the last two weeks of June (to 32 million
shares). Days later, the company would declare bankruptcy, reaping
a huge payday for short sellers.
bets also paid off in consumer electronics retailer
. The short position of nine million shares amounted to a whopping
55% of the total
. So after an announcement that quarterly results were dismal,
shares slumped a hefty 37% on Wednesday July 11.
Call it dumb luck, but the four biggest losers thus far in the
third quarter were all heavily shorted. Indeed, whether it's
an expected weak quarter or an outright bankruptcy declaration,
short sellers are clearly on their game right now. You may want to
check out the short position on any of your holdings, and if it's a
large one, then you need to quickly learn why the short sellers are
so bearish. In this market, there's no shame in raising cash, and
these heavily-shorted stocks may be good candidates.
So where else are the shorts focused? Here's a quick look at
four stocks, and why the shorts see downside ahead.
1. Chesapeake Energy (NYSE:
Even after responding to shareholder requests for a more
responsible board of directors, and even after a nice rebound in
natural gas prices, short sellers still hold 85 million shares
short (which, admittedly is down 5 million from mid-June but still
ranks as the 11th-highest short position on the NYSE). Shares, near
$19, are actually showing some resilience, even after the
Journal continues to run
a series of stories
questioning the company's unstated financial relationships and
perhaps overstated gas reserves estimates.
Chesapeake's bulls and bears both make a solid case, and shares
are either wildly
or undervalued, according to who you listen to. I can't make heads
or tails of it myself. For further insight on this stock, you may
want to read Nathan Slaughter's views on Chesapeake in his
Scarcity & Real Wealth
newsletter, if you haven't already.
2. Rite Aid (NYSE:
Shares of this lagging drug store chain have fallen from above
$2 in late March to a recent $1.33, which would typically lead
short sellers to cash in their winning bet. But they actually
boosted the short position by 6 million shares to 58.8 million at
the end of June.
Any time you see a stock trading below $2 with a large short
position, you might wonder if this is a candidate for bankruptcy.
Will that be the case?
Well, Rite Aid is sitting on more than $6 billion in debt. This
means the retailer needs to pay out $130 million in interest
expense every quarter. That's a larger sum than
, which means that Rite Aid continues to generate quarterly net
losses. You can't do that in perpetuity if you have $6 billion in
3. Arch Coal (NYSE:
After scoring a big hit with Patriot Coal, short sellers are
targeting this debt-laden rival. As is the case with Rite Aid, Arch
Coal has to make huge quarterly interest payments -- roughly $75
million per quarter. Trouble is, the coal miner had just $54
million in operating income in the first quarter -- yielding a
-- and second quarter results are likely to be even worse as coal
prices keep on dropping.
4. Facebook (Nasdaq:
After a disappointing debut, shares of this huge
staged a decent short-term rebound, as
would happen in mid-June.
Nearly a month ago, I suggested shares would get a lift from a
fresh wave of research reports from the company's underwriters in
late June. But I also cautioned that actual second-quarter results,
set for release later this month, might be fairly tepid. "This
suggests booking profits if shares rebound in coming weeks," I
wrote back then.
Some short sellers think that's much too passive a strategy and
they see a compelling short play emerging. In just the two weeks
ended June 29, the short position in Facebook rose a hefty 33% to
60 million shares. Such a large short position implies that the
stock will make a big move when second-quarter results are
released, as results will have been as weak as the short-sellers
anticipate, or good enough to make the shorts cover and trigger a
short squeeze. If you have a strong feeling either way, then puts
and calls may be the best way to capture any near-term move.
Risks to Consider:
As an upside risk, any heavily-shorted stock can post a massive
quick gain -- if the short sellers are wrong in their assumptions
and are forced to cover their positions.
Action to Take -->
The market feels winded, having dropped on most trading sessions
this month. That may have led to some profit-taking by
short-sellers, though the real action will come when second-quarter
results are released for each of these stocks. There are times to
go against short sellers (for example, a rising market could
trigger squeezes). But this is not one of those times. It may be
wiser to steer clear of any heavily-shorted stocks right
-- David Sterman
David Sterman does not personally hold positions in any
securities mentioned in this article. StreetAuthority LLC owns
shares of CHK in one or more if its "real money" portfolios.