Palm shares rally on takeover talk, short covering

* Shares rise 20 percent, after sharp decline in 2010

* Merger rumor cited, but seen as “unsubstantiated”

NEW YORK/CHICAGO, April 7 (Reuters) - Shares of Palm Inc PALM.O jumped 20 percent on Wednesday as investors covered short positions on renewed speculation that the smartphone maker may be an acquisition target.

The stock, which has tumbled some 60 percent this year on concerns about flagging sales [nN19134642], has a high percentage of short-seller investors, who bet on a share price decline but cover positions if they see signs of a potential rally.

“Basically, it’s renewed takeover speculation,” said option strategist Frederic Ruffy. “It’s unsubstantiated, but due to the fact that Palm has been so beaten down in recent months, the talk triggered heavy short covering and a noticeable move higher in the share price.”

Palm rallied as high as $4.65, before trading up 75 cents at $4.60 early Wednesday afternoon on Nasdaq, where it was one of the most active issues. Palm declined to comment on the stock move.

David Russell, an analyst at Chicago-based options and equity trading website, said that short interest in Palm was above 40 percent of the outstanding shares as of March 15, making it susceptible to a short squeeze.

“The shares had been stuck below $4 since about March 25,” Russell said. “Once the stock broke resistance this morning there was a huge surge of buying which is consistent with a short squeeze.”

In the options market, trading is brisk. According to option analytics firm Trade Alert, about 64,000 calls and 25,000 puts traded, above the combined average daily level of 52,000 contracts in the afternoon session.

Investors often use calls -- giving them the right to buy the company’s shares at a fixed price by a certain date, to speculate on share price appreciation or as a hedge to cover their short positions.

Palm has for years been mentioned as a potential takeover target for much larger companies -- such as Lenovo Group 0992.HK [nLDE63205T] -- hoping to enter the mobile market or expand their presence.

In the past, technology companies Dell Inc DELL.O and Microsoft Corp MSFT.O and handset manufacturer Motorola Inc MOT.N have all been named as potential suitors. [nN23396446].

Owning Palm could help bolster a company's mobile presence and provide a challenge to Apple Inc's AAPL.O iPhone and Research in Motion's RIM.TO BlackBerry devices. Many analysts have called a deal unlikely, citing the cost of buying Palm and integrating its technology.

Piper Jaffrey analyst Michael Walkley said on Wednesday that Palm sales may have improved in March, but he still expects Palm to struggle to compete “without improving sales of its products at key carrier partners such as Verizon Wireless.”

(Reporting by Franklin Paul in New York and Doris Frankel in Chicago; Editing by Richard Chang)

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