April 29, 2026

How Do Investors Short Biotech Stocks, Is Every Biotech Stock Shortable, and What is a Naked Short?

Funds that short stocks (hedge funds) are said by academics to make capital markets more efficient.

That’s all very well in theory – where perfect information exists and markets function flawlessly – but anecdotally, it doesn’t quite feel the same when you’re an illiquid biotech in your first or second year of being public, you see a decline in your stock price, and you hear rumors of hedge funds shorting your stock.

Periodically then, I am asked by my clients if their stock is being shorted, by whom, and often why.

This blog aims to explain how investors go about the process of shorting biotech stocks. It should be read in conjunction with my other two blogs “What is the Typical Short Interest in a U.S. Public Biotech?” and “What Is a ‘Short Report’ and How Common Are They in Biotech?”

What does it mean to “short” a stock?

To short a stock is to bet on the price of a stock going down. How do you do that?

The answer is, you borrow some stock from someone who owns it – with the understanding that you will give it back to them at some pre-agreed future point in time – you sell it, wait for the price to drop, and then buy the stock back again and return it to the original owner.

Let’s go through a simple example to see how that might make someone money.

Example 1:

Shorting a stock and making a profit

Sarah believes that ABC Therapeutics’ stock is going to fall because she thinks its upcoming Phase 3 results are going to be bad. She wants to try and make money from her thesis, so she decides to short ABC Therapeutics’ stock.

Sarah borrows 100 shares in ABC Therapeutics from Tim when the price is $10 per share. She promises to return the 100 shares to him in a week’s time (after the Phase 3 readout).

Sarah then sells the 100 shares she’s borrowed at $10 per share and sits on the $1,000 in proceeds she receives (100 x $10).

In the subsequent week, ABC Therapeutics’ Phase 3 results are bad and the stock falls to $2.Sarah now buys back the 100 shares she sold at $2 per share for a total consideration of $200.

Sarah returns to Tim the 100 shares she borrowed – as promised, one week after borrowing them – and keeps the $800 profit she just made.

Key to understanding how shorting occurs is understanding why there are investors prepared to lend their stock to others, and who they are. Not surprisingly, the chief reason that investors lend is that it leads to better outcomes for them – or put simply, they get paid to do so.

Why do investors lend stocks to other people?

Let’s expand upon our prior example and now add in a fee charged by Tim to Sarah for the loan of his stock.

Example 2:

Shorting a stock and making a profit (with fees)

Let’s say Tim charged Sarah 1% for the weekly loan of his stock in ABC Therapeutics.Based on the $1,000 original value of the stock he loaned, his fee would be $10.

Sarah sells the 100 shares she’s borrowed at $10 per share for gross proceeds of $1,000.

The price still falls to $2 after the negative Phase 3 results.

Sarah buys back 100 shares for $2 per share at a total cost of $200.

Sarah now returns the 100 shares to Tim in addition to the $10 fee he charged her for borrowing his stock.

Importantly, even when a stock goes up (and the shorter loses money), a lender will still have secured a better outcome for themselves by loaning the stock out beforehand.

Example 3:

What happens when the stock goes up?

Tim once again charges Sarah 1% for a weekly loan of 100 shares in ABC TherapeuticsBased on the original value of the stock he loans (100 x $10 =$1,000) his fee is $10.

Sarah sells the 100 shares she’s borrowed at $10 per share for gross proceeds of $1,000.

This time the price doubles to $20 per share after ABC Therapeutics announces positive Phase 3 results.

Per her contract with Tim, Sarah now has to buy 100 shares for $20 per share at a total cost of $2,000.Sarah returns the 100 shares to Tim and also pays him the $10 fee for borrowing his stock.

Tim is now sitting on stock worth $2,000 plus an extra $10 in cash for lending his stock. Sarah just made a loss of $1,010 (which is $2,000 + $10 in expenditures, minus the $1,000 she made on selling 100 shares at $10 per share).

Lenders make better outcomes regardless of what happens to the stock:

	Outcome for Tim if he did not lend his stock	Outcome for Tim if he lends his stock
ABC Tx stock goes down (Phase 3 results negative)	Loss of $800	Loss of $790
ABC Tx stock goes up (Phase 3 results positive)	Profit of $1,000	Profit of $1,010

Who then are the funds lending stocks?

The largest sources of shares to borrow are custodian banks and prime brokers. These institutions hold shares on behalf of clients – pension funds, mutual funds, ETFs, hedge funds, and other long-only investors.

When a hedge fund wants to short a stock, its prime broker locates shares from this pool and borrows them. The beneficial owner typically doesn’t notice: the shares still appear in their account, voting rights are retained, and dividends are passed through as so-called “manufactured dividends.”

Passive funds and ETFs are especially important lenders. Because they hold large, stable positions and rarely trade based on fundamentals, lending stock is an easy way for them to generate incremental yield.

Margin accounts are another key source. If shares are held in a margin account, the broker generally has the contractual right to lend them out. Retail investors often agree to this without realizing it. Fully paid cash accounts are usually excluded, though some brokers offer opt-in lending programs.

Finally, it’s important to note that shares can be re-lent, i.e., a borrowed share is sold short, purchased by another investor, and then lent again. This creates lending “chains” and explains how the short interest in a company can approach, or even exceed, 100% of a company’s public float.

Not every stock is shortable

Now, not every stock is shortable. During the campaign for the 2024 U.S. Presidential Election, Donald Trump’s supporters pushed the value of his NASDAQ-listed Trump Media and Technology Group Corp (which owned the social media platform Truth Social) to stratospheric levels.

It looked like an obvious short – since it had 36 employees and was heavily loss-making.

But no one could borrow the stock to short it.

Trump himself owned around 59% of the company, while other insiders owned stock as well. As such, there simply wasn’t a “sophisticated institutional shareholder base” from whom one could borrow the stock, and as such it was prohibitively expensive to short.

Most biotechs in their first and second years are similarly illiquid (not to mention small), making them difficult targets for short sellers. Moreover, a biotech’s stock price can jump in either direction on news that no one saw coming: a clinical hold or a patient death on the downside; or a takeover offer or unexpectedly positive results on the upside. Short sellers typically prefer predictability and liquidity since these help reduce their risk.

Naked shorts

Lastly, let’s talk about naked shorts – the bogeyman every paranoid executive or board director  likes to blame when their stock is in the dumps.

What are naked shorts? Well, naked shorting involves someone selling a stock without already having owned or borrowed it first.

How do they do that? They do it by fudging the trade; naked short selling is typically characterized by a failure to deliver stock on the appropriate settlement date –  a metric keenly monitored by financial regulators studying stock trends.

Because a post-sale failure to deliver stock is so visible, investors attempting to naked short a stock will always get caught.

For further context, naked shorting has been illegal since the SEC banned it following the 2008 financial crisis, when the practice took off as investors bet on the collapse of Lehman Brothers and Bear Sterns.

To summarize: naked shorting is illegal and incredibly rare, and extremely unlikely to be the reason your biotech’s stock is depressed.