Big Short Squeezes Could Be Looming For Major Energy ETFs

There is no getting around the fact that the recent performances of the Energy Select Sector SPDR XLE and the SPDR S&P Oil & Gas Exploration and Production ETF XOP are not exactly awe-inspiring. From May 31 through June 10 XLE tumbled about 5% while XOP slid about 8% as the high-beta trade and risk appetite has diminished in a big way. An interesting thing has been happening on the way to coliseum regarding these two ETFs that makes them worth a nibble, yes, even here: Massively rising short interests. Short interest in XLE jumped 18% last month after a 16% pop in April and now a third of the ETF's shares outstanding are sold short, according to OilSlick.com. XOP is an even more mind-blowing situation. Shorts have dug in to the tune of more than 53 million shares, nearly 3.5 times the ETFs total shares outstanding. For now, the short trade is working, but it is also messing with fire when it comes to XLE and XOP. When the market rebounds, energy stocks will likely regain their leadership roles and why not? Oil prices are far higher than they were a year ago, meaning XLE's and XOP's constituents, at least 90% or more of them, are going to post better profits than they did last year. It's really this simple: About the only companies not named Apple AAPL that are a total lock to make more money in 2011 than they did in 2010 are oil companies. That's slight hyperbole as many companies will post stronger profits this year than they did in 2010, but we can take it to the bank that Exxon Mobil XOM, Chevron CVX and friends are going to make more in 2011. A lot more. XLE has a beta of 0.96 and an average true range of 1.68. For XOP, those numbers rise to 1.10 and 1.73, which is another way of saying that when the short squeeze comes for these ETFs, it is likely to be violent and punishing for the shorts, yet highly rewarding for those with the fortitude to take a shot on one or both ETFs in advance of the squeeze. What makes the prospect of a short squeeze for XLE and XOP all the more compelling (and alluring) is common sense. Meaning, shorts can decimate a stock or ETF that has poor fundamentals and still be vulnerable to buyers stepping in just because that security has beaten up too much too fast. In the case of XLE and XOP, there is precious little wrong with the fundamentals of the ETFs' constituents. When buyers come to the rescue of energy stocks, particularly the ones found in XLE and XOP, they're doing so because they want to be involved for more than a day or a week and because the fundamentals are strong. Bottom line: In ETF-ville, XLE and XOP are two of the better short squeeze candidates you're going to find at the moment.