The biotech sector comes with a large ‘buyer beware’ sticker; most stocks in the sector are prone to volatile moves depending on the efficacy of their drug pipelines and on FDA approval, cautions Patrick Martin, editor of Schaeffer's Investment Research.

Reading biotech tea leaves can be boiled down to dart throws at knowledge that’s esoteric to even the most seasoned investor. But what if there was a way to cut through the noise, and at the very least, identify common contrarian threads with biotech stocks?

The top three holdings of the SPDR S&P Biotech ETF (XBI) are ImmunoGen (IMGN), Viking Therapeutics (VKTX), and TG Therapeutics (TGTX). These three stocks — and a few others — are all ripe for a short squeeze that could continue to catch bearish bettors leery of biotech volatility off guard.

Schaeffer’s Senior Quantitative Analyst Rocky White recently compiled a table of stocks where the shorts might be at a big loss and therefore likely to begin covering. It consists of names where short interest has increased by at least 25% since it’s low over the past year, ranked by stocks for which the shorts are at the biggest loss (at least 10%).

One caveat, per White: “Obviously, there are quite a few assumptions, so these would be very rough estimates. To estimate the return for the shorts I went back over the past year of short interest reports to find when the shorts were added. Then I used the average price over the prior two weeks and estimated the shorts were added at that average price. I use a weighted average by increase in shares short to find the average price the shorts are in at. Then I calculate the return the shorts are at.”

You can see that a squeeze could already be in for IMGN, with a slim 3.6% of its total available float now sold short, down roughly 50% from 7%. ImmunoGen stock is up 259% year-to-date, one of the biggest winners of 2023 so far.

VKTX is 152% higher year-to-date, with chart support at its 40-day moving average in place and a healthy 11% of its total available float sold short.

89bio (ETNB) may not be a top holding of XBI, but at the stock’s average pace of trading, it would take shorts five trading days to buy back their bearish bets. ETNB has tacked on 66% in 2023 and 521% year-over-year.

It’s a similar story with TGTX, with chart support at the 50-day trendline, and yet 8.8% of its total available float sold short. Another name to monitor is Axsome Therapeutics Inc. (AXSM), with 18.5% of the stock’s total available float sold short.

As a reminder, there’s still a great deal of risk to biotech stocks that aren’t blue chips like Merck (MRK) or Amgen (AMGN). And the names above are all outperforming at such a rate that there could be a ‘FOMO’ rush, by taking a flier on them now.

Thus, in lieu of tying up cash with share purchases (or accepting the steep risk profile and margin requirements of selling shares short), one can reduce cash outlay and overall market exposure through the purchase of options, while still participating in a stock's directional movement.

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