What happened

Shares of HEXO (NASDAQ:HEXO), a Canadian cannabis producer, are clocking significant gains even though everything's quiet on the northern front. The marijuana stock gained 12.6% as of 12:52 p.m. EST on Tuesday in what looks like a textbook example of a short squeeze.

So what 

Around 12.3% of Hexo shares available for trading are sold short. That isn't as disturbing as the percentage for some of Hexo's cannabis-producing peers, but it's enough to cause a panic among short-sellers.

Confused trader looking at screens

Image source: Getty Images.

If you've never heard of a short squeeze, or you've just been afraid to ask for a clear explanation, they're really not too complicated. It's what happens when people with short positions lose their cool. 

Holding short positions requires nerves of steel because stock prices have no upper limits and the market can remain irrational longer than most traders can remain solvent.

Around 29.7 million of Hexo's shares available for trading are tied up in short positions. On an average day, only 4.2 million shares change hands. That means it could take a week and a half before short sellers can replace all the shares they borrowed from their brokers.

Now what

To make shareholders who bought near the stock's peak in April whole again will take a lot more than a minor short squeeze. Over the 12 months ended July 31, 2019, Hexo reported just CA$47.3 million in net revenue while operating expenses soared to CA$111.5 million. 

Hexo likes to consider itself a packaged-goods company similar to General Mills or Kraft Heinz. Both of these companies sport operating margin percentages that generally hover in the high teens.

If packaged-goods industry margins are Hexo's goal, the company needs to accomplish something amazing. Without adding one Loonie to annual operating expenses, sales would need to more than double. Betting on Hexo's ability to reach that goal seems like a bad idea.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.