Regarding short-squeezes: the way to avoid getting squeezed out is to not have on outright short positions (or excessively large option premium exposure) once market sentiment reaches panic levels. Even if the stock is ultimately going to zero, if you get a 100% rally then your short sucked and was wrong. So, any time the VIX gets high enough you need to cover outright shorts and shift to short-dated puts. Same if your favourite short has a blizzard of bad news and is down 50% intraday or some such. Either it gets wiped out in a week or two or it doubles/triples in the same period. A good example was FNM/FRE in July, I had been short as a core position but shifted over to the puts and placed stops on my outrights once they had got down into single digits. As a result I took some losses once the bottom was in, but it was far less painful than if I had stayed outright short. And my long-dated puts (which I held) have now recovered all their losses and are above where they were a month ago. If you are ultimately right then the Jan 09/10 puts are the way to go - they give ultimate staying power. Book some put profits into panics, cover your outrights (or at least bring stops up), and only keep on short-dated puts once panic is in the air.
I had the same issue with stocks like CFC and MBI in 07 and early 08. It takes a while to get the hang of it and I'm not fully there, but shifting from long-dated puts to outright shorts to short-dated puts as the fear and thus the bounce/squeeze risk gets higher seems to me the best way to play it.
I did a pretty extensive post-mortem after that July rally, here are my main conclusions:
1) With a short, it is not enough to think the stock is going down massively over the long-term. You must also have a high conviction that the stock is not likely to rally 75-100% or more in the meantime. If you think the stock could realistically double, then use puts not outrights.
2) When panic selling and huge price declines occur, especially if on some kind of negative news announcement, or if the VIX approaches panic levels (30+), then you should always book some profits, and minimise your exposure to a short squeeze. My preferred way is to cover outrights and/or use close stops, take profits on most of your long-dated puts, and shift the remaining exposure you want to short-dated puts (real or synthetic by buying calls).
3) If you are still convinced of the long-term case, then once the rally gets going, wait for sentiment to become complacent and the stock overextended, then start averaging into long-term puts, buying a few more each week for the next month or two until you get up to full exposure. This worked well in Feb, April/May, and looks to be working well again now. Because they are puts, you don't risk getting slaughtered by averaging.
I had the same issue with stocks like CFC and MBI in 07 and early 08. It takes a while to get the hang of it and I'm not fully there, but shifting from long-dated puts to outright shorts to short-dated puts as the fear and thus the bounce/squeeze risk gets higher seems to me the best way to play it.
I did a pretty extensive post-mortem after that July rally, here are my main conclusions:
1) With a short, it is not enough to think the stock is going down massively over the long-term. You must also have a high conviction that the stock is not likely to rally 75-100% or more in the meantime. If you think the stock could realistically double, then use puts not outrights.
2) When panic selling and huge price declines occur, especially if on some kind of negative news announcement, or if the VIX approaches panic levels (30+), then you should always book some profits, and minimise your exposure to a short squeeze. My preferred way is to cover outrights and/or use close stops, take profits on most of your long-dated puts, and shift the remaining exposure you want to short-dated puts (real or synthetic by buying calls).
3) If you are still convinced of the long-term case, then once the rally gets going, wait for sentiment to become complacent and the stock overextended, then start averaging into long-term puts, buying a few more each week for the next month or two until you get up to full exposure. This worked well in Feb, April/May, and looks to be working well again now. Because they are puts, you don't risk getting slaughtered by averaging.