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(Bloomberg) -- Investors should beware a potential short squeeze in French stocks as the beaten-down market has already priced most of the potential political stress.

Benjamin Melman, global chief investment officer at Edmond de Rothschild Asset Management, said French blue chips have already priced in most of the stress from the possible fall of Prime Minister Michel Barnier’s government.

“The situation in France remains worrying but beware a short squeeze,” said Melman, referring to a situation when investors who were betting on the fall of an asset need to urgently buy back their positions when the market goes against them. That could fuel further gains in the securities they’re selling.

Far-right leader Marine Le Pen and her National Rally party have vowed to support a no-confidence motion submitted by a left-wing coalition on Wednesday. The outcome of the vote later Wednesday could have significant implications for France’s government, economy, and politics, including a government collapse and increased borrowing costs.

France’s CAC 40 index has largely underperformed its European peers since President Emmanuel Macron called surprise snap elections in June. French blue chips are down 3.5% in 2024 while the pan-European Stoxx 600 has gained about 7.9%.

The one-month volatility for the CAC 40 has remained elevated, while the DAX equivalent has been dropping fast. That’s opened an unusual gap that tends to close very quickly after risk events, just like it did over the summer.

“The CAC has massively priced French political risk, the discount on French stocks is becoming significant,” Melman said. The downward trend has, however, stalled, with the index set for a fifth straight day of gains on Wednesday.

Similarly, the yield premium between 10-year government bonds and safer German equivalents, a closely watched gauge of risk which recently touched 90 basis points — the widest since 2012 — has tightened and is now trading at around 83 basis points.

For investors looking to hedge the worst case-scenario in France, buying put options on the Euro Stoxx Banks index offers protection against a further selloff in the country’s bonds, Barclays Plc strategists including Anshul Gupta said in a note. But traders should also consider hedging against upside in case of a “short-term bounce,” they said.

“While the assets closest to French political risk are already reflecting rising political premium, they could likely continue to face headwinds,” the strategists said. “On the other hand, the materially light positioning and negative price action arguably suggest a lot of negativity is likely baked into flows/pricing. Consequently, any last-minute compromises and avoidance of the worst-case scenario can potentially lead to a short-term bounce in CAC.”