If a firm designs a great new product, a more efficient production process or gains some other privately known competitive advantage, then the firm could financially profit by short selling its competitors’ stock before revealing its advantage. The revelation reduces the expected discounted profits of competitors, thus their stock price. Symmetrically, if a firm loses cheap suppliers, suffers a manufacturing breakdown or otherwise becomes less able to serve its customers, then its competitors will probably benefit and their stock will rise. The firm could mitigate its losses by buying rivals’ stocks, with leverage.

Shorting competitors does not seem to be illegal insider trading, as defined by the US courts: the purchasing or selling a security while in possession of material, non-public information concerning that security, where the information is obtained from a breach of fiduciary duty, or a duty arising from a relationship of trust or confidence. I am not a lawyer, so this is just a guess, but a firm usually does not possess inside information about its competitors and does not owe fiduciary duty or trust to its rivals. Maybe there is some other reason not to trade in competitors’ stock, but a casual web search did not reveal why.