Let's assume for a moment that we had it wrong. Since we started covering solar stocks at The Panelist, we've been working with the assumption that solar valuations appear stretched. Love him or hate him, Mad Money host Jim Cramer also added his voice to the emerging consensus that solar valuations have gone too far.

Despite these high valuations, I still believe that there are opportunities to make money in this sector due to the lack of consensus on when the polysilicon shortage will end. Let's say that solar valuations are justified at current levels. If that is the case, short sellers are in for some pain. This article is about how you can turn the short seller's pain into profit.

If you're not familiar with the term "short seller", please click here. By definition, short sellers believe that stock prices are overvalued. I made a list of a few solar stocks that have seen investors increase short positions over the last month. The data was last updated on June 12. I have also included a ratio of (shares shorted/total shares outstanding) for each stock.

Perhaps a more meaningful ratio for our discussion would be the "short ratio." The "short ratio" is defined as the short interest in a stock divided by the daily trading volume. This indicator shows how many days of trading volume is required to cover the short interest. A high short ratio raises the probability of a short squeeze. If you're not familiar with the phrase "short squeeze," please click here. The following list relates to data that was last updated on June 12.

I believe that there is a good opportunity to profit from a short squeeze on ENER and ESLR. I'd be hesitant to suggest a short squeeze strategy on SPWR, since the stock looks ready for a pullback. I find it fascinating that there aren't more shorts on FSLR. Let's look at the macro and micro factors, and how these factors may lead to short covering on both ESLR and ENER.

On a macro level I remain a bull on stocks, and I don't think ENER and ESLR will be dragged down by a broad decline in equity values. It has now become apparent that the more the Fed talks and the less they do, the better the outlook is for them. The bond market has been doing a lot of the heavy lifting for the Fed at this point, and the Fed probably won't have a need to increase rates as long as the inflation outlook remains in line. I feel that the most likely scenario is that the Fed will remain neutral but tone down its inflation language, and this will likely give a big boost to stocks.

Despite news that Germany’s Environment Ministry recommended a shift in subsidies from solar energy installations to offshore wind farms, I still believe that solar's macro outlook is encouraging. Solar is likely to see massive growth in the U.S. on the back of the new energy bill being passed. I believe that the good news from a growing market in the U.S. is good enough to outweigh the negative news from the mature German market. The biggest near-term risk for solar stocks is a big sell-off in investor darlings SPWR and FSLR. If we had to see a sharp correction for either of these companies, the entire solar sector could suffer from the spill-over effect.

Also, don't forget that crude is trading above $71. Iranian tensions aren't going away, hurricane season is upon us, and few expect Nigerian militants to start waving white flags any time soon. Despite the lower correlation between oil prices and solar stocks, I feel that alternative energy technologies will see solid investor demand as oil prices remain at these elevated levels.

With a solid macro outlook for solar stocks, the downside for the likes of ESLR and ENER should be limited. 

For ESLR, I suspect that short sellers will be forced to cover their positions if the company decides to become a technology-licensing company. As we have suggested before, ESLR could license its String Ribbon wafer technology and reinvent itself as a business that generates a few hundred million in revenues with nearly 100% gross margins. Although I don't believe ESLR is a takeover target, there are some who feel the company looks like a great acquisition.

And as far as ENER is concerned, short sellers are likely to cover their positions after management recently announced that they are cutting R&D expenditure for management's money-wasting pet projects. As we previously discussed, there could be some upside in the share price now that the company is focusing on opportunities to commercialize its existing technologies.

In closing, solar valuations may look expensive, but if solar technology eventually proves to be commercially viable, the valuations of today will look cheap 5 years from now. If current solar valuations are indeed justified, the likes of ENER and ESLR could benefit from short sellers covering their positions.

Disclosure: I do not own any of the stocks mentioned above. I do not own a solar panel.

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