Short sellers are generally considered blasphemers by biotech firms. And for good reason; short sellers borrow shares in order to sell them, which puts negative pressure on the stock. The only way shorts make money is if shares go down.

But biotechs don't have much to complain about, according to data compiled by BMO Capital Markets. Short sellers are only slightly more active in the biopharma sector than they are for the entire Nasdaq. Looking at the short interest as a percent of equity float since the beginning of 2007, the 302 publicly traded biopharmas used in the study had a mean of about 6.6 percent of their available shares sold short, which is only about a percentage point higher than the short interest for all the Nasdaq stocks.

Considering the large number of binary events in biotech – data read-outs, FDA decisions, etc. – Annette Grimaldi, managing director at BMO, thought the absolute difference might have been larger. One possible reason is that the binary events also detract short investors because the losses on a short position are theoretically limitless, unlike a long position where the most an investor can lose is the initial investment.

The means of the short interest ratio – dividing the short interest position by the average daily trading volume – were nearly identical at 7.8 and 7.6 for Nasdaq and biopharma stocks, respectively. In other words, it would take almost eight days for the shorts to cover all their outstanding short sales at the average trading volume.

Both the short interest as a percent of equity float and the short interest ratio spiked in the middle of 2008 during the peak of the recession. That's not surprising as both measurements describe how safe it is to put on a short position. As the numbers increase, it becomes harder to unwind the short.

Despite continued volatility in the market, the measurements of short activity have returned to normal levels.

There has, however, been a slight widening of the short interest as a percent of equity over the last two and a half years between biopharma and Nasdaq stocks, with the biopharma stocks closer to 1.5 percentage points higher than the Nasdaq stocks, up from the previously mentioned mean of about 1 percentage point. Grimaldi offered up a couple of potential explanations: "It may mean that they're betting against the sector or there may just be a larger number of companies where it would be profitable to put on a short position."

Not every short position is made by an investor who believes the shares are overvalued. Short sales are used to hedge long positions in either the individual stock, the sector, or the entire investor's portfolio. They can also be used as a tax deferral strategy.

Shorts also increase liquidity of shares, which can be helpful for biotechs. Higher liquidity, for instance, helps firms sell more shares in at-the-market (ATM) offerings, a public offering alternative that has slowly gained traction over the past few years. Inhibitex Inc. raised $20 million through an ATM last month. (See BioWorld Insight, Sept. 7, 2009.)

And short sellers can actually have a positive effect on shares if a company produces positive news. A short squeeze occurs as the short sellers cover their sales by buying back shares, amplifying the upward movement of the stock in response to the good news.

While shorts might be best ignored from an industry perspective, Grimaldi thinks individual firms should probably consider why investors are shorting the shares. "Especially large short interest is a signal that differs from what management is saying. For that particular company, they should look to see if there are any underlying messages in that position."

China Biologic Products Inc., Cumberland Pharma-ceuticals Inc., MannKind Corp., BioTime Inc., and Oncolytics Biotechnology Inc. currently top the list of companies with the highest short interest.