Biotech investment is fraught with risk. Most biotech stocks are at the mercy of binary events, which serve as make-or-break catalysts. These binary events, however, provide an opportunity for making huge profits for those investors placing the right bets.
Even if the outcome is expected to be negative, one can still make money by adopting a strategy called shorting, which is a bet placed on the price of the security falling in the near future.
Pros And Perils Of Shorting
The mechanism of shorting works like this: borrow a stock and sell it at the prevailing market price, hoping to buy it back later at a less price in order to square up the position. Since the short bet is placed on the premise the security will decline in value, one can make a neat profit out of the price differential between the purchase and sale transactions.
Contrary to expectation, if the stock price begins to move up, a short seller would be left staring at a loss. The situation gets worse when several short sellers, in a bid to cut their losses, scramble to buy the stock, pushing the stock price up further. This is known as a short squeeze.
Why Biotech Stocks Are Ideal Candidates For Short Selling
Most binary events have prescheduled deadlines, giving a clear idea on the investment timeframe.
For instance, Lexicon Pharmaceuticals, Inc.'s (NASDAQ: LXRX) sotagliflozin faced a FDA panel review in mid-January, with the reviewers handing out a split verdict. The investigational asset had a PDUFA action date of March 22. With the writing on the wall fairly clear, a short seller could have got away with a bet against the stock.
The stock slumped about 23% following the Adcom decision, and plunged 29% over two sessions after the FDA refused to approve the diabetes drug candidate.
That said, the inherent volatility and low float characterizing biotech stocks make shorting a risky proposition. One can end up losing money if the bet goes awry. A short seller trying to cover up his short position in the event of a short squeeze may not be able to buy the stock, especially when it is of a low float.
Metrics Associated With Shorting
The short interest is denoted in absolute number of shares shorted. This apart, short interest is expressed as a percentage of float. Another metric called short ratio refers to the number of days it would take to cover the short positions. Mathematically, it's the number of shorted shares divided by the average daily trading volume, expressed in percentage terms.
Here are the some of the heavily shorted stocks in the biotech stocks (based on data from shortsqueeze.com):
- Intrexon Corp (NASDAQ: XON): short interest 52.79%, short ratio 34.9
- AMAG Pharmaceuticals, Inc. (NASDAQ: AMAG) short interest 48.46%, short ratio 16.4
- Ligand Pharmaceuticals Inc. (NASDAQ: LGND) short interest 44.95%, short ratio 19.5
- Polarityte Inc (NASDAQ: PTE) short interest 38.02%, short ratio 17.4
- Paratek Pharmaceuticals Inc (NASDAQ: PRTK) short interest 37.60%, short ratio 17.2
- Eidos Therapeutics Inc (NASDAQ: EIDX) short interest 36.47%, short ratio 15.5
- Axsome Therapeutics Inc (NASDAQ: AXSM) short interest 36.25%, short ratio 11.5
- Heron Therapeutics Inc (NASDAQ: HRTX) short interest 34.02%, short ratio 18.2
- ZIOPHARM Oncology Inc. (NASDAQ: ZIOP) short interest 33%, short ratio 35.7
- Cronos Group Inc (NASDAQ: CRON) short interest 30.23%, short ratio 8
- Akcea Therapeutics Inc (NASDAQ: AKCA) short interest 30.19%, short ratio 16.5
- Viking Therapeutics Inc (NASDAQ: VKTX) short interest 29.57%, short ratio 13.6
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