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|Includes: Novavax, Inc. (NVAX)

Nvax Case Study:
Looking at HT's data has been very illuminating.  It cleared up a lot of questions I had about shorting, and in answering those questions, it changed my perspective on shorting..

At Least Two Kinds of Shorting Behavior:
HT's data clearly shows that Nvax's stock price has been adversely affected by shorting.  The main sequence in the price by percent shorts chart (Figure One - blue line) tells us that each dollar increase in the stocks price is associated with an increase of 1.4 % shorts.  So the typical short play appears to be based on regression to the mean logic. The higher a stock price, the higher the probability it will return to its mean value over some recent time period.  The time period is probably strongly related to the mean stock price over the past 30 days.

However, HT's data (Figure Two) also shows us that at least one other kind of shorting exists. Shelf Induced Shorting. Right at the stocks peak price, management announced a shelf offering of 6.8M shares priced at $3.3 per share. I interpret that as management saying "that even though the stock is currently priced at slightly over $6 per share, management feels it's only worth $3.3 per share". After all, how much is a ten dollar bill worth if you sell it for five dollars? At this point, "smart money" started to short the stock beyond the amount predicted by our regression to the mean model. 

A quick explanation of how shorting works helps us understand the reasoning behind the "smart money" play. When you short a stock you are selling "borrowed" shares at the current price.  Because of the increased selling volumn, the price for the stock drops. The shorters now buy back the shares on the open market to replace the shares they borrowed and bank the difference minus charges.

When management announced their shelf offering on September 15, they signalled a shorting opportunity. The smart money started borrowing shares of Nvax high priced stock, sold them, and re-purchased at a lower price.  In this situation, the likely minimum lower price was pegged by management at $3.3 per share. So the smart money did not even have to figure out the lower valuation for the stock.

As the stock price decreased, regular investors lost interest in the investment and they begain to sell their holdings. This established what is known as a self reinforcing feedback loop.  The smart money was likely borrowing, selling, and re-purchasing shares all the way down. This produced downward pressure on Nvax current holders, who also sold their shares (See Figure Three).

What happens next?  By now, the really smart money has settled their short positions. However, as can be seen in Figure One, the current percent of shorts is 9 percent higher than expected based on the stocks current price.  The stock has stabilized at about $2.75, and there are about 9% more shorts out there beyond that predicted by the stocks valuation, that have not settled out of their short positions. My guess is that these people just jumped on the short bandwagon but really did not understand the underlying basis of the move.

Meanwhile, Nvax is conducting second stage clinical H1N1 trials in Mexico. Given that the first stage trials were successful, its probable that the second stage will also be positive. As Nvax management stated on December 6 (2009), 'It'll be of little use to launch H1N1 vaccine after 3-4 months'. Nvax is planning to launch the product in Mexico during the first quarter of 2010. First phase rollout of the product in India is planned for between February and March of 2010. 

When the successful clinical trials are announced, very likely in January 2010, the stock price should pop. How much will it pop? Under normal circumstances, HT's data suggests it will pop by between $1.5 and $3 per share.

Short Squeeze?
However, as we know, the Nvax short position  is currently larger than normal. In order for those shorts to prevent loosing money, they are going to need to buy Nvax shares at the lowest possible price. If the second stage clinical trials are successful, they are going to need to immediately buy Nvax shares. This should result in a Short Squeeze spike when successful clinical trials are announced. Of course, if the clinical trials are unsuccessful, or there is any kind of time delay with respect to approval for human use, the stock price will drop more and the shorts will make more money.