Biotech stocks tend to be very volatile, and that has some traders thinking that they will revert to the mean after any nice run. But with the potential for positive catalysts — like successful clinical trial data — the danger of shorting a biotech hoping for it to revert to the mean is heightened. You could be looking at a pop-and-go situation, where the stock simply moves higher.
Consider the case of Cara Therapeutics (CARA) , a clinical-stage biotechnology company, where someone might have shorted the stock after a significant run in the wake of the U. S. Food and Drug Administration (FDA) granting the company a breakthrough-therapy designation for its lead drug candidate. Cara then reported that it would be continuing Phase III trials of I.V. CR845 in patients with post-operative pain. These positive catalysts sent the stock higher, without any reversion to the mean.
There were signs that you might not have wanted to short Cara. Here are some key statistics:
When a stock has a short interest, or short float, above 20%, it’s usually an indication that shorts could get squeezed, in the event of a positive catalyst. That said, if you were part of this 23.89% of floating shares that were short, you would have gotten squeezed after Cara Therapeutics had two positive catalysts.
As you and the other shorts were rushing out of the stock, it simply pushes the price higher.
Here’s a look at how the stock performed as the shorts were squeezed after these catalysts.
The bottom line
Biotech and pharmaceutical stocks get increasingly volatile around news events, and when the stock has a high short interest coupled with a low float, it could indicate that the shorts might get squeezed and the stock might jump significantly higher if the catalyst event turns out positive.
Kyle Dennis runs Kyle Dennis’ Biotech Breakouts (biotechbreakouts.com). He is an event-based trader, who prefers low-priced and small-cap biotech stocks.
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