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While blockchain mining enterprise Riot Platforms Inc (NASDAQ:RIOT) has been one of the market's top performers, the good times never last indefinitely. Thanks in part to political pressure, RIOT stock fell sharply on Friday. Still, amid the noise, an undercurrent within the security's short interest has developed that just might signal an explosive move down the line.
At the moment, President Donald Trump has once again stolen the limelight with another market-rippling social media post, this time threatening a sweeping increase in tariffs on Chinese imports. In response, the broader equity indices tumbled while gold and silver prices moved up.
"Some very strange things are happening in China! They are becoming very hostile and sending letters to countries throughout the world that they want to impose export controls on every element of production involving rare earths," Trump wrote on Truth Social.
The president stated that he would "financially counter" Chinese efforts to monopolize rare earths, hinting that one of the measures could be a "massive increase of tariffs" on Chinese goods entering the U.S.
While the political drama doesn't necessarily affect the cryptocurrency market directly, it pivots investor dollars away from risk-on, growth-oriented enterprises to traditional safe havens, such as gold. Combined with fears of a bubble brewing in the technology space, many investors decided to take profits from RIOT stock, along with other crypto-focused names like MARA Holdings Inc (NASDAQ:MARA) and Coinbase Global Inc (NASDAQ:COIN).
Undoubtedly, it's a risky environment. Still, the red ink may present a possible discounted opportunity.
Right now, the short interest of RIOT stock stands at 18.3% of its float, which is quite high. Though there's no hard figure to officially determine what a "bad" reading is, generally speaking, a level of 10% or greater is considered a warning sign. Essentially, this figure means that a good chunk of the target security's available pool of shares are loaned out for shorting purposes.
At face value, a high short interest represents a bearish signal. However, when this metric is elevated for popular securities such as RIOT stock, short interest could be a contrarian indicator. This stems from a potent combination of psychological pressure and real financial pain known as the short squeeze.
All short transactions carry what's known as tail risk, the ever-rising threat of an obligatory payment as the underwritten event gets realized to the extreme ends of the distribution. To cut this tail risk off early is more prudent. However, to exit a short transaction is the opposite of exiting a long transaction; that is, short traders must buy to close.
When an excess volume of short traders want to exit at the same price all at once, that's when you get the short squeeze.
Now, what's fascinating about RIOT stock is that, while its short interest has long been elevated, it has had only a modestly strong inverse relationship to the underlying share price:
During these four years, the average coefficient was -49.75%. However, in the year so far, the coefficient comes in at -83.24%.
Sure, from a simplistic view, the idea is that as short interest falls, the RIOT stock price rises. But the much more fascinating inference is that the statistical tightening of these two metrics increases the possibility of a massive short squeeze.
In other words, RIOT stock may have shifted its sentiment regime; now, it could potentially respond much more strongly to its underlying short interest than to the fundamentals or other exogenous factors.
If the above analysis is correct and the sentiment regime has shifted (or is beginning to shift), then RIOT stock could be on the cusp of an explosive rally. In that case, a long-expiry call option would be on the table. For example, the $25 call expiring Jan. 15, 2027 is intriguing in part because the bid-ask spread at the midpoint is about 4.38% (at time of writing).
Yes, the ask is at $7.00 per option, meaning that RIOT would have to hit $32 a share to break even on an intrinsic level. Ordinarily, that would be excessively aggressive. However, short squeezes can easily get out of hand for the bears. Therefore, it's not unrealistic, so long as the squeeze actually materializes.
For those who are looking for a short-term trade, the 21/23 bull call spread expiring Oct. 24 may be your best bet. This transaction involves buying the $21 call and simultaneously selling the $23 call, for a net debit paid of $85 (the most that can be lost in the trade).
Should RIOT stock rise through the second-leg strike price ($23) at expiration, the maximum payout is over 135%. Further, the breakeven price is $21.85. Essentially, you would be looking for the bulls to temporarily drive up RIOT stock following today's volatile session.
The opinions and views expressed in this content are those of the individual author and do not necessarily reflect the views of Benzinga. Benzinga is not responsible for the accuracy or reliability of any information provided herein. This content is for informational purposes only and should not be misconstrued as investment advice or a recommendation to buy or sell any security. Readers are asked not to rely on the opinions or information herein, and encouraged to do their own due diligence before making investing decisions.
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