Bed Bath & Beyond is in the midst of a massive short-squeeze as bearish traders play game of chicken with potential bankruptcy

• Bed Bath and Beyond is in the midst of a massive short-squeeze, with the stock up 230% in four days.
• Short-sellers in the declining retailer profited $179 million in 2022, but are down more than $30 million in 2023, according to S3 Partners.
• Short-sellers in Bed Bath & Beyond are essentially playing a game of chicken as they await a potential bankruptcy filing.

Bed Bath & Beyond has had a wild start to 2023, with the stock up more than 230% in just four days as traders pile into the home furnishings retailer and spark a short-squeeze.

Prior to this week's surge, shares plunged to levels not seen since 1992 after management warned that deteriorating financials could lead to bankruptcy.

Now investors on both sides of the stock are playing a game of chicken in terms of whether Bed Bath & Beyond actually moves forward with filing for bankruptcy. 

According to data from S3 Partners, short-sellers in Bed Bath & Beyond have an incentive to hold onto their position, after generating $179 million in profits in 2022. While 2023 is off to a rocky start for short-sellers, having lost more than $30 million year-to-date, there could still be a big payoff ahead.

"If the threat of bankruptcy becomes more of a certainty the prospect of a Bed Bath & Beyond short squeeze becomes less and less, we can expect minimal short covering as short sellers wait for a $0.00 stock price," S3's Ihor Dusaniwsky said in a Wednesday note.

But if the retailer continues to hold its own and is able to successfully navigate its precarious position, more fuel could be added to the short-squeeze fire and send the stock price soaring. 

"If the stock continues to rally, we could see more near-term short sellers exit their positions and begin to pocket (realize) the profits they earned in 2022," Dusaniwsky said. 

For now, traders are holding onto their bearish Bed Bath & Beyond positions, as the stock currently has a short interest of $82.7 million, representing almost 40 million shares and 52% of the company's float. That makes Bed Bath & Beyond the second most shorted stock in the market based on short interest.

Whichever direction Bed Bath & Beyond moves from here, one thing is almost a near certainty, according to S3: it's going to be volatile.

That's because Bed Bath & Beyond has lost the support of institutional investors as they sold the stock over the past few years, making it mostly held by retail investors on the long side and institutional traders on the short side.

"This mix makes for a volatile stock since fundamentals are not the primary driver of price moves - the stock is becoming much more of a momentum and technical name - outsized and sudden price fluctuations will not be out of the ordinary," Dusaniwsky said. 

To that effect, shares of Bed Bath & Beyond were up more than 20% in early Thursday trades, after surging nearly 70% on Wednesday.