Investor fear of retail has turned to despair, with bets against the sector reaching the highest level since the collapse of Lehman Brothers.

Short interest — a measure of how many shares are being sold short compared with the total "float," or shares outstanding — has reached a post-financial crisis peak of 15.6 percent, according to Bespoke Investment Group. The larger set of consumer discretionary stocks has a short interest level of 11.7 percent, the highest since March 2009, around the time of the crisis lows for the stock market.

Both figures are as of the end of August and were released Tuesday. Short-sellers borrow shares to sell for a period of time, hoping to pocket the difference when they buy them back.

Source: Bespoke Investment Group

There's a fairly obvious culprit for all the fear — that Amazon will continue to grow and ultimately swallow its competitors who can't compete in the online retail space. Consumer discretionary is expected to be one of only three sectors to post a year-over-year earnings decline in the third quarter, with the current projection at 3 percent, according to FactSet.

"The reason for the negative sentiment towards retail stocks is obviously the 'Death by Amazon' trade as well as the shift in consumer preferences towards experiences over products," wrote Bespoke founder Paul Hickey.

In the financial markets, the fallout has been palpable — with Amazon's shares up more than 32 percent in 2017 while the retail sector, as measured for the SPDR S&P Retail (XRT) exchange-traded fund sliding more than 6.5 percent. The ETF has not only vastly underperformed Amazon but also the broader market, where the S&P 500 has gained 11.5 percent.

Traders are looking to cash in on the trend, then, with big short bets that will pay off if retail keeps underperforming. The big question is whether all of the negativity might start to work in the other direction. The XRT fund is up about 9 percent since Aug. 21, including a rise of more than 3 percent this week.

"The action in the group this week has been pretty explosive. The one thing about crowded trades is you can have that countertrend rally," said Art Hogan, chief market strategist at Wunderlich Securities. "Right now, the group is acting like a powder keg, with a high level of short interest, and it doesn't take much news to flip these things around."

Some of the leading retail names in terms of short interest are Under Armour (28.3 percent), Kohl's (20.9 percent) and Nordstrom (16.2 percent), which is likely to go private.

Hogan said to keep an eye on companies such as Nike, Wal-Mart and T.J. Maxx with "concepts that are workable that aren't necessarily Amazonable." And he advises caution when chasing the short-retail trade.

"It's going to be a long battle, and Amazon's got the upper hand," he said. "But in terms of investing, you've got to be careful and know what you're doing."

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