Find Big Returns With Short-Squeezes

by: Larry Meyers

I've been keeping an eye on three stocks of companies in big trouble. In fact, I believe all three will eventually end up in bankruptcy. The trick with these plays, however, is that you can't just short them, because everyone else is already doing just that. Instead, you can be prepared by actually going long and waiting for the intermittent short-squeezes. These stocks can rocket higher in just a few days, and then give those gains right back again. It's a game of psychology, made all the more difficult by what it costs to borrow shares when they are scarce.

Case in point: Education Management Corporation (NASDAQ:EDMC). The for-profit secondary school sector has been under fire by the Obama administration for some time. A company like DeVry, Inc. (DV) is fairly well-insulated from these issues because it has $449 million in cash, no debt, tons of free cash flow, and a solid business that can survive the watered-down regulations that have come out of the DOE.

In normal circumstances, Education Management might struggle, but do OK. Unfortunately, it is being sued by the DOJ, which alleges significant wrongdoing. I shorted the stock at $17, having to borrow it at a relatively modest rate of 2% per month. Believing that even a settlement would cost the company dearly, I figured this was a good short. If the DOJ won its case, Education Management would have to file for bankruptcy. A funny thing happened recently, however. On no news, the stock shot from $14.50 to almost $20 over seven trading days. It felt like a short-squeeze.

I didn't mind. I was resolute in my thesis. Until my broker called and said the interest rate being charged by the lender of short shares just went to 70% annually. Ouch. I was forced to cover. The good news is that now I know short-squeezes are likely being planned ahead of time by the powers that be. Education Management had hit a whopping 44 days to cover, blasting up from only 9 days. My plan is to wait for it to fall below $15 again, wait for the short interest to rocket back up, buy the stock, buy some puts to cover myself on the down side and wait for the squeeze to happen.

The same thing obviously happened to Life Partner Holdings, Inc (NASDAQ:LPHI). On July 15, the stock hit 16 days to cover, with 18% of the float short, and stock at 4 bucks and change. The short squeeze began, taking it rapidly to $8.65. It's now down to $6.25. Life Partners is in a world of trouble, and I don't think it stands a chance. The SEC investigation on this company is very serious, calling into question the very basis under which the company exists. Again, look for days to cover and short interest hitting the mid-teens to buy in for a possible squeeze. Remember to cover your position with puts.

You'll have to pay big money to borrow shares of SodaStream International (NASDAQ:SODA) to short. Last I checked, it was 30%. Short interest on April 29 was 17% of float with 6 days to cover, near a peak of historical days to cover. Sure enough, on May 18, the stock flew up ten points to $53, and kept going to $61. The squeeze hit yet again in late June, and the stock went to $75. So wait and be patient for that 6 days outstanding to show up, along with about 3 million shares short to jump in.

Other stocks to watch for short squeezes include Tesla Motors (NASDAQ:TSLA), which was last at 21 days to cover (near its high of 30, with 58% short interest; Bridgepoint Education (NYSE:BPI), which is at 23 days to cover, creeping towards its high of 41 days with 51% short interest, OpenTable Inc. (NASDAQ:OPEN) with 49% short and headed towards the 6 days to cover mark; Coinstar (NASDAQ:CSTR), which has 36% shorted and halfway to its 17 days to cover target, and everyone's favorite target as of late, Clearwire Corporation (CLWR), with 28% short interest and also halfway towards its 15 days to cover target.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.