Investors Betting Against Tesla Could be Headed for 'Short Squeeze Hell'

The most shorted stock in the world, Tesla, may experience a prolonged short covering rally after bets against the maker of electric vehicles saw mark-to-market losses of $1 billion on Thursday.

In a note to clients on Thursday, S3 Partners, a short-selling research company, warned that Tesla could be in for "short squeeze hell," especially after CEO Elon Musk made encouraging remarks during the company's second-quarter earnings call.

According to a transcript of the call, Musk claimed that Tesla has "the potential for a record-breaking second half of the year" after production records at its factories in Shanghai and Fremont in June. Tesla's second-quarter earnings beat analyst expectations, which contributed to a stock gain of up to 10% on Thursday.

Short-sell covering, which happens when short sellers buy Tesla stock in the open market to close their losing positions, also contributed to Thursday's rally. According to S3 Partners, Tesla's short interest currently has a notional value of $18.5 billion.

Tesla, which is currently the ninth most popular long position among hedge funds, could support a rally driven by momentum as short sellers scramble to cover their positions.

"With Tesla's stock price rallying and short sellers incurring $1 billion of mark-to-market losses today, we should expect its short covering trend to continue as short sellers get squeezed out of their positions due to these large and sudden losses," S3 Partner's Ihor Dusaniwsky said.