Struggling retailer J.C. Penney (NYSE:JCP) on Thursday reported earnings that surpassed analysts’ expectations. As a result, the stock surged more than 20 percent in after-hours trading. During Friday’s trading session the stock rose over 16 percent on volume of 96 million shares — five times more than normal and nearly a third of the total shares outstanding — to close at $9.73 per share.
The results and the positive market reaction have generated a slew of positive remarks on the company. However, despite the improvements in the company’s numbers there is still a lot of risk in the stock.
First, if we look at the market reaction, the reason that the stock popped so much was probably panic coming from short sellers, not new buying. Before Friday, more than 30 percent of the outstanding shares of J.C. Penney were sold short, as investors anticipated continued weakness in the company’s stock. Short selling is a very risky proposition, because while your upside is limited to 100 percent, if the stock goes to 0, your downside is unlimited because there is no limit to how high a stock can rise.
Therefore, even fundamental short sellers need to approach short selling with a trader’s mentality. This means using stop orders and cutting one’s losses if the position goes against you. In all likelihood, many of the buyers didn’t buy because they were impressed by the company’s performance. Rather, they were concerned about the market’s reaction to non-catastrophic news.