Options Corner: Short-Squeeze Pressure Continues To Fuel Freshpet's Contrarian Rally

On paper, pet food products specialist Freshpet Inc FRPT should be struggling for traction — and on a wider scale, it certainly is. Since the beginning of the year, FRPT stock is down about 45%, a staggering loss. Further, mixed results from the company's first-quarter earnings report didn't help improve the picture. Nevertheless, the market has other ideas, making the equity an intriguing idea for risk-tolerant speculators.

At the start of this week before the opening bell, Freshpet disclosed first-quarter revenue that increased 17.6% on a year-over-year basis to $263.25 million, outpacing analysts' consensus view of $260.12 million. Volume gains of 14.9%, along with a favorable price/mix of 2.7%, contributed to the lift in net sales.

However, the financial performance went off course in terms of the bottom line. Specifically, the adjusted loss per share landed at 26 cents, missing the consensus target of earnings per share of 10 cents.

Moreover, despite management's positive framing, it was difficult to ignore the obvious concerns facing Freshpet's core business. Admitting the obstacles inherent in the current economic paradigm, the leadership team lowered its fiscal year 2025 sales outlook from a range of $1.18 billion to $1.21 billion, down to $1.12 billion to $1.15 billion. On the other end, analysts were anticipating an outlook revision to $1.18 billion.

Still, even with these overall disappointing figures, FRPT stock has been on the rise. Helping to fuel upward speculation is the security's elevated short interest. Presently, FRPT's short interest as a percentage of float clocks in at 15.3%. What's more, the short interest ratio stands at 4.99 days to cover, meaning that it would take one week (based on average trading volume) for the bears to unwind their position.

In other words, this short squeeze — or the "reverse" panic stemming from being on the opposite side of market momentum — could last for some time.

Trading FRPT Stock While The Deck Is Hot

Although it doesn't look like it given the security's penchant for devastating volatility, FRPT stock historically demonstrates an upward bias. Using data since January 2019, the chances that a long position will be profitable over a one-week span is 54.38%. In its natural state, investors can generally expect decent performance out of this solid middle-capitalization entity.

However, from a trading perspective, 54% isn't that much of a probabilistic edge. Indeed, with such a small advantage, going for big payout strategies may represent a speculation trap. Instead, it may be better to wait for the target security to enter a more advantageous phase — essentially when the deck becomes hot in favor of the bettor rather than the house.

Statistically, it's improbable for a publicly traded security's baseline odds to stay static across sentiment regimes. During periods of extreme fear or greed, the odds of long-side success may shift dramatically from the baseline, presenting superior setups for speculators.

Regarding Freshpet, in the last 10 weeks, its stock printed a "3-7" sequence: three weeks of upside combined with seven weeks of downside, with an overall net negative trajectory across the period. The significance of this pattern is that it appears to be a reversal signal. First, there have only been two cases of 2-8 sequences in the past 10 years.

Second and more importantly, there's a 62.79% chance of upside in the subsequent week following the flashing of the 3-7 sequence. What's more, the median one-week return under the positive pathway stands at 5.1%, whereas the median loss under the negative pathway is 3.14%. Thus, the risk-reward profile from a payout perspective is also asymmetrically favorable to the bullish speculator.

Plotting An Aggressive Multi-Leg Strategy For Freshpet

Over the next 10 weeks, if the positive pathway wins out, FRPT stock could see an early swing higher before the momentum tapers off, resulting in a price target around $81. Should the negative pathway win out, investors may see some choppiness before a stabilization point around $77.

It all comes down to the short squeeze, which is notoriously difficult to predict.

Aggressive traders may consider the 82.50/85 bull call spread expiring May 16, which is probably the highest one can reach for while still being rational. This transaction involves buying the 82.50 call and simultaneously selling the $85 call, for a net debit paid (at time of writing) of $130. Should FRPT stock rise through the short strike price of $85 at expiration, the maximum reward is $120, a payout of over 92%.

If all goes to plan, the above trade should take advantage of any remaining momentum from the potential short squeeze. However, if circumstances go awry, the bull spread's capped-risk profile would keep the most that can be lost at the net debit paid of $130.

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