Why biotech attracts short sellers

Biotechnology and pharmaceutical companies dominate the list of most shorted stocks with earnings announcements this week—and for good reason, experts told CNBC.

These companies make up six of the 18 stocks with the largest percentage of outstanding shares on loan reporting this week, according to Markit. The bets against these firms—most of which have a relatively small market cap—are usually stock-specific, but the industry as a whole offers unique opportunities for short sellers.

"What makes biotech amenable to this type of investing is that at the end of the day you get a 'yes' or a 'no' answer on a drug," said Stifel Nicolaus senior analyst Brian Klein. "Those binary events allow you to make bets with large swings, so you can make a lot of money as an investor on either end of a stock."

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But even before a final decision is made, the biotech industry has regular sets of deadlines that are conducive for short sellers, whose bets in other industries could take years to pay off.

These regimented timetables offer investors "higher-than-average potential for stock-specific news," especially for the smaller pre-commercial stocks whose fortunes ride on a single product, said Chad Messer, Needham & Co.'s senior biotechnology analyst.

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Both Messer and Klein cover Geron, a California-based biotechnology company that ties for 12th on Markit's weekly list of most-shorted stocks. Ahead of Geron's earnings, about 13.9 percent of the company's shares outstanding are on loan, according to Markit.

Both analysts maintain a "hold" on the company. Earlier this year, Geron's only drug, imetelstat, received a Food and Drug Administration clinical hold for its trials to treat a rare type of blood cancer, but Messer and Klein both indicated that they expected the issue would blow over.

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This sort of news, and the lingering questions about imetelstat's efficacy compared to its toxicity, explain why bears are piling into the stock, they said.

Another heavily shorted biotechnology company announcing earnings this week is facing less defined fears about its future. PDL BioPharma ranks third on Markit's list with 22.6 percent of its shares outstanding on loan.

Rather than deadlines for clinical trials, the company is dealing with investor concern over the viability of its business model, said RBC Capital Markets analyst Adnan Butt. For the past few years, PDL BioPharma has operated as an owner of biotech patents and royalty assets, but the strategy has a "young history," Butt said.

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Despite the short sellers identifying this strategy as a potential weakness, many investors are sticking with the stock—keeping it above $9 per share—because of its high dividend, said Kimberly Lee, senior biotech analyst for Janney Montgomery Scott. Both Lee and Butt have a "hold" rating on the stock.

Here's Markit's complete list of most shorted stocks with earnings announcements this week:

—By CNBC's Everett Rosenfeld.

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