Earnings preview: Shorts seem nervous ahead of PepsiCo's 3Q

During the past 10 days, option traders on the Chicago Board Options Exchange (CBOE) and the International Securities Exchange (ISE) have bought to open 4.92 calls for every put on PEP. In other words, speculators have snapped up nearly five times more bullish bets than bearish. This ratio ranks higher than 98% of other such readings taken during the past year, as calls have been purchased over puts at a faster pace only 2% of the time.

Ordinarily, this heavy call volume ahead of earnings would be a red flag from a contrarian perspective, since it could indicate that investors' hopes have risen too high. However, it's worth noting that short interest on PEP has bolted higher in recent months, and now totals 19.4 million shares. This hefty accumulation of bearish bets marks the highest number of shorted PEP shares in years, indicating that the bullish bandwagon is hardly overcrowded.

In this context, it's possible that some of the recent calls were purchased as hedges by the shorts, in order to guard against a potential upside earnings surprise. Those lingering skeptics should also be spooked by PEP's solid technical performance -- the shares have surged consistently higher since March, and they're currently enjoying the solid support of their 10-week moving average.

Overall, PEP looks well-positioned to benefit from a potential short-squeeze rally after earnings, should the company continue its pattern of beating Wall Street's expectations. In fact, even if the firm can't manage an upside surprise, any downside could be limited by a combination of short-covering and technical support.

Elizabeth Harrow is an analyst and financial writer in the research department at Schaeffer's Investment Research. She is featured in the video series Schaeffer's Daily Q&A on SchaeffersResearch.com.