How risky are these heavily shorted COVID stocks?

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Short sellers have their eyes on Vir Biotechnology (NASDAQ: VIR) and Sorrento Therapeutics (NASDAQ: SRNE). Short positions represent 22% and 26% of their free float respectively. Free float refers to stocks available to the general public for trading.

The immediate risk is that so many investors are betting that these stocks will go down. Another concern may be the possibility of a short squeeze – followed by a sharp drop in the share price. But the biggest risk of all for Vir and Sorrento is that their COVID-19 candidates are still in clinical trials.

Image source: Getty Images.

How do shorts work?

Let’s talk about short positions first. Short selling occurs when investors now borrow stocks to sell them at market price. They then have to buy it back later to get back to the lender. The objective is to buy it back at a lower price – and therefore to take advantage of the whole mechanism. A short squeeze occurs when something drives the stock up – and those who sold it short scramble to buy back stocks. This pushes the stock even higher. The problem is, once this movement is over, it usually falls back to earth. We have recently seen this happen with GameStop (NYSE: GME).

The potential alignment of Vir

Now let’s take a look at where Vir and Sorrento stand in terms of potential products.

Vir is working on three candidates for the treatment, and in some cases prevention, of COVID-19. The most advanced in the testing process is VIR-7831. With partner GlaxoSmithKline (NYSE: GSK), Vir is studying this antibody therapy in two Phase 3 clinical trials, one for early outpatient treatment and the other for subsequent inpatient treatment. VIR-7831 works by binding to part of the coronavirus antigen, neutralizing the virus and killing infected cells.

Vir and GlaxoSmithKline have joined forces with Eli lilly (NYSE: LLY) for another study. The companies are testing VIR-7831 in combination with Lilly’s antibody therapy in low-risk patients with mild to moderate disease. The United States Food and Drug Administration (FDA) has already granted Lilly Emergency Use Clearance (EUA) for its antibody as an individual treatment.

Sorrento’s longest list

Like Vir, Sorrento has several coronavirus candidates in the works – 11, to be exact. Candidates include potential diagnoses and treatments. Here, the more advanced are two diagnoses. The company has submitted an EUA application for one and plans to do so for the other. The diagnosis of the coronavirus is already a rather crowded space. The FDA has already authorized more than 300 products developed by various companies and research centers.

I think Sorrento’s most exciting COVID-19 candidates are in early stage studies. The company recently announced positive results from its Phase 1b trial of the investigational COVI-MSC stem cell therapy for acute respiratory distress. The four patients treated with the candidate saw their condition improve and were discharged from the hospital within a week.

There are two other interesting candidates. Sorrento is testing abivertinib in Phase 2 trials for the reduction of coronavirus-induced inflammatory cytokine storms. Cytokine storms occur when the immune system gets out of hand and the body attacks its own cells. Sorrento is also aiming to start a Phase 1 trial for COVI-DROPS, a neutralizing antibody nasal spray. It would be for the treatment of mild cases of coronavirus.

Considering all of this, how risky are Vir and Sorrento?

I wouldn’t be too worried about short positions. The results of Vir and Sorrento’s COVID-19 programs represent more of a direct risk than the short-lived situation. It is not uncommon for companies participating in such a high interest area to attract short sellers. The short percentage of Moderna‘s (NASDAQ: mRNA) free float, for example, reached 10.4% in August of last year, up from around 6% in February. It came as investors bet on the prospects for its coronavirus vaccine program.

The development programs of Vir and Sorrento include interesting candidates. And so far, their data has been encouraging. In the case of Sorrento, a concern is that the company might have too much coronavirus candidates in preparation. It might be better to focus on the most promising. That said, the market outlook for a key candidate, such as abivertinib, could be significant.

Vir, too, could score a big win for its revenue and share price with the potential clearance of one of its coronavirus candidates. But the risk also remains significant for these companies. The movement of their stock price is heavily dependent on coronavirus news. And a stumble or complete failure in any of their tries could result in significant share losses.

Nonetheless, I wouldn’t look into short positions to see whether to avoid these biotech stocks. Instead, it’s best to look at your own risk tolerance. If you are an aggressive investor looking for a company that may be one of the next winners of the coronavirus treatment competition, you might consider buying Vir or Sorrento shares. However, victory is not guaranteed. So, if you’re not comfortable with the risk, you’d better watch it sideways, at least until the product candidates get closer to the market.

This article represents the opinion of the author (s), who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are heterogeneous! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are heterogeneous! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.

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