Summary
- Carvana is an auto retailer that is fundamentally doing extremely poorly.
- With J. Powell sounding dovish yesterday, investors have started to cover more short positions.
- CVNA is the second most shorted stock at 59% of float, and was up more than 33% yesterday.
- Investors expecting a linear move down to $0 for the stock are in for a big surprise.
- We are going to witness an epic rally in the next few days in CVNA, driven by shorts being squeezed out.
Thesis
We have covered Carvana ( CVNA ) before here , where we outlined an options based strategy to take advantage of the developing financial troubles the company is experiencing. In our article we said the following:
The options strategy put forward involves buying puts. We went forward with a theoretical example involving 10 contracts. When buying puts, a retail investor is only exposed to losing the premium paid for the options (as opposed to short selling where the downside is unlimited) . In our example, if the Carvana stock price is above $7.5/share in January 2024, then the puts would expire worthless, and the investor would lose the $4,000 premium amount.
Short-selling can be extremely painful, especially for overextended stocks, or names where everybody and their mother and shorting the equity:
Most Shorted Stocks (MarketWatch)
Carvana is the second most shorted stock currently, and in the next few days it is going to end up going much higher. With chair Powell sounding dovish yesterday, we saw a monster rally in duration sensitive tech and a wave of short covering. This is just the beginning of a massive wave of short covering for a number of the top names in the table above. Counterintuitively CVNA will smoke out a number of shorts before resuming its fundamentally driven downward spiral.
What many market participants fail to understand is that nothing is linear in financial markets - just because a company is set to fail from a profitability / cash-flow perspective, that does not make the event linear. The crowding out effect is actually more important - the higher the number of investors piling into a trade/view, the higher the propensity for violent and substantial counter-moves. It is akin to a stretched elastic that snaps. We are going to see the same move here in Carvana in the next few days, with a snowballing effect - people who shorted this name sub $10/share will rush to cover because they are losing a whole lot of money right now. In our opinion we are setting up for an epic short squeeze in Carvana, similarly to what we saw a few years back with GME. And you have J. Powell to thank for that. If he was uber hawkish yesterday then the market would be in risk-off mode. Conversely a dovish Fed will now unleash the next wave of short covering, driving markets higher and loosening financial conditions further.
How to triple your money in 2023
Bankruptcies are strange affairs. Balance sheet, free cash flow - all the fundamental based metrics sometimes get lost in translation when the herd trading mentality takes over:
CVNA Price Performance (Seeking Alpha)
If someone would have told you that you could triple your money in the first 32 days of the new year by buying Carvana, would you have believed them?
Yes, it is entirely a speculative move driven by a large short in the stock, but it is reflective of how dangerous short selling is for retail investors. An average retail investor should always use bought options in our mind, never short sell. The squeezes can be epic, and they do not always follow the company fundamentals. Retail investors are famous for being contrarian indicators, and that is because they tend to dive into a financial instrument when a trend is already established - when you see everybody is selling Carvana, then you sell it too thinking it is a good trade. Wrong. By the time a retail investor is short selling Carvana, everybody else has already done that, so you are putting yourself in a position to be squeezed out by a reversal rally.
Conclusion
Carvana is an auto retailer that is fundamentally doing extremely poorly. The name has been covered ad nauseam on Seeking Alpha from a fundamental stand-point, so we won't re-iterate those points. However, nothing is linear in financial markets. Investors expecting a linear move down to $0 for the stock are in for a big surprise. With J. Powell sounding dovish yesterday, investors have started to cover more short positions. CVNA is the second most shorted stock at 59% of float, and was up more than 33% yesterday. We are about to witness another epic short squeeze 'à la' GME, with individuals that shorted the name sub $10/share feeling the heat. We have covered this name before here , where we looked at an options based strategy to bet on CVNA's demise (we are short CVNA via bought puts - i.e. our downside is the premium paid only). While sometimes expensive, bought puts protect a retail investor from stomach churning short squeezes. And we are about to witness an epic one for Carvana.
For further details see:
Carvana: We Are Likely To Witness An Epic Short Squeeze