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One popular type of play that traders often look for is stocks that have unusually high short positions (example) ahead of an upcoming catalyst for the possibility of a short squeeze. The most commonly used method to measure the size and theoretical strength of a possible short squeeze is measured by a short interest ratio, which is the short interest divided by the daily average volume. The theory goes that the higher the number the more illiquid the stock is relative to the buying (covering) interest that would follow. This lack of supply versus long demand can cause a short squeeze with shorts aggressively buying shares to cover their positions. Sometimes even they are forced to cover due to margin calls, causing forced buy-in and unusually high buy volume and upwards movement. Generally a short ratio over 3 be would considered to be high, as it represents a full 3 days of volume for shorts to cover their positions.

A huge short ratio though can be a double-edge sword. Sometimes the reason for the unusually high short interest is simply due to a traders being aware of an upcoming event such as a bad earnings report versus analyst expectations. As an example, investors in Skullcandy (SKUL) learned this the hard way. SKUL had a short ratio over 10 despite analyst estimates for a cheap-looking forward PE of under 10 and a history of sales and EPS that consistently was beating analysts handily. But when the earnings came out, SKUL slashed guidance and the stock got crushed on competition fears. The lesson learned with SKUL is although many times betting on a large short ratio can lead to a short squeeze, it's far from a sure thing. But there's plenty of short squeeze opportunities with earnings reports that often fair better.

On December 5, there happens to be 4 companies reporting that have excessively large short ratios. Earnings can often be the right catalyst to cause a short squeeze though of course the risk is higher as seen with SKUL. Despite the results of SKUL, often times large short positions ahead of a catalyst like an earnings report = potential opportunity. See the table below for a list of 4 stocks in order from smallest to largest short ratio (all data taken from shortsqueeze.com):

SymbolShort InterestAverage VolumeShort Ratio
ASNA4,644,5001,180,3003.9
VRNT2,409,000334,2007.2
FRAN12,087,400908,40013.3
VRA11,322,900384,00029.5

(1) Ascena Retail Group (ASNA) - after hours

Ascena Retail Group, Inc., through its subsidiaries, operates as a specialty retailer of apparel for women and tween girls. Its principal retail brands comprise Justice, Lane Bryant, maurices, dressbarn, and Catherines brands. It has a tendency, though not always, to beat earnings estimates. With a PE of 10 vs. fiscal 2014 estimates, it looks cheap to me with any even small surprise beat. With a short ratio of near 4, a mini short squeeze could take place.

(2) Verint Systems (VRNT) - after hours

Verint Systems Inc. provides Actionable Intelligence solutions and value-added services worldwide. Its solutions are used to capture, distill, and analyze underused information sources, such as voice, video, and unstructured text. Nothing overly exciting, but they tend to beat estimates. I'm not thrilled with all the insider selling, but they are a solid earner expected to grow steadily going forward. I don't see much realistic downside risk with the report, but with a short ratio of over 7 the shorts disagree. This one should be a hard move in one direction or the other, depending on who's right.

(3) Francesca's Holdings Corporation (FRAN) - pre-market

Francesca's Holdings Corporation, through its subsidiary, Francesca's Collections, Inc., operates a chain of retail boutiques under the francesca's collections brand in the United States. Simple story: sales, earnings, and growth of both are all on fire. Some insider buying in September. Insider buying + a short ratio over 13 is usually a recipe for disaster for shorts. Rarely do shorts know better than insiders who are buying shares of their own company in the open market. I wouldn't want to still be short going into the report.

(4) Vera Bradley (VRA) - after hours

Vera Bradley, Inc., through its subsidiary, Vera Bradley Designs, Inc., engages in the design, production, marketing, and retail of stylish and functional accessories for women under the 'Vera Bradley' brand. Its products include a range of handbags, accessories, and travel and leisure items. VRA is expected by analysts to have a solid report and continue to grow both top and bottom line. There was a variety of officers buying in the open market earlier this year. With a strong holiday season, VRA could report a nice surprise and cause a short squeeze. Do the shorts know more than insiders? I highly doubt it. 29.5 short ratio is just out of control extremely high. This could turn into a textbook squeeze fast.

Source: 4 Stocks With Large Short Interest Ratios Reporting December 5