Manufacturing a Short Squeeze ~ The Risk Averse Alert

Wednesday, March 11, 2009

Manufacturing a Short Squeeze

It is a good bet that, if bottom is not already in, it is near.

Not sure whether you heard, but one of the Fast Money traders indicated short-sellers he knew covered 50-60% of their positions on Tuesday, rather than just 10-20% as had been the case previously. There's a very compelling explanation, I believe: the growing likelihood the uptick rule will be restored.

I believe its elimination in July 2007 played no small part in facilitating the market disaster that followed (almost like clockwork). Thus, I suppose its coming reinstatement likewise will have an impact, playing well into a positive market outlook over months ahead.

Look at it this way. The uptick rule is likely to level the playing field in the present, fear-filled environment ... taking away a profound power of action capable of elevating uncertainty and creating a negative feedback loop. It's a whole lot easier adding to a short position when the trade is moving in your favor than when it is moving against you.

Bulls make money, bears make money and pigs get slaughtered. It's difficult imagining there is not an inordinate speculative short interest ripe for the harvest.

So, how might shorts be squeezed like orange juice?

Well, let's consider the writers of Call options hedging short positions ... how do they hedge their positions? Alas, they go long the underlying.

This, then, is a prospective vulnerability created by elevated Call option buying of late. In other words, pronounced short equity hedging potentially sets up the more rapid unwind of the trade. Furthermore, pressure applied, pre-expiration (3.20.09), might only exacerbate the effect.

So, bottom might be in. Of course, nothing is set in stone, but if this week goes out recovering all of last week's losses, and some, next week could be spectacular.

Fast Money
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Anonymous said...


I respect your thinking, but I feel that the short covering has removed the bottom from the market and any plunge could be devastating.

I know this perspective may be extreme, but I sincerely expect Dow 5000-5500 within the following month.

I think this downswing from Jan. 6 is going to end with a bang not a sideways, weak volume bottom, like Friday and Monday.

I expect many stocks that have been relatively insulated like MCD, WMT, XOM, COP, IBM, GOOG, as well as gold and silver to fall steeply alongside all other markets, as this will be the liquidation phase of this brutal bear.

Good Luck.