Image source: via Flickr.

Short sellers have been betting against an FDA approval of Sarepta Therapeutics' (SRPT 0.59%) Duchenne muscular dystrophy (DMD) drug, eteplirsen, and I can't say I blame them.

Sarepta Therapeutics has been hoping for accelerated approval of eteplirsen, which means that an FDA decision is being based on phase 2 trials that included only a dozen patients and that evaluated efficacy versus a historical control, rather than a placebo.

Those trial results failed to persuade a key FDA advisory committee that reviewed eteplirsen in April. The committee voted 7-to-6 that Sarepta Therapeutics failed to demonstrate that eteplirsen boosts dystrophin to levels high enough to extrapolate a clinical effect, and it voted 7-to-3 that the company failed to demonstrate that eterplirsen effectively treats DMD patients. 

Following the committee's decision, the FDA decided to indefinitely delay its official go/no-go decision while it digests and debates more data.

In most cases, a history like that would be the undoing of a drug. However, eteplirsen isn't just any drug. DMD is a hard-to-treat, life-threatening disease, with a poor prognosis, and a big need for new treatment options. 

Nevertheless, eteplirsen's stumbles make it unsurprising that short sellers have amassed a 16.2 million-share bet against the company. Heading into today, 38% of Sarepta Therapeutics shares available for trading were being held in the hands of bears.

What may be surprising, however, is how quickly that big short position caused a run-up in Sarepta Therapeutics' share price today. Following news that one of eteplirsen's chief critics, Ron Farkas, left his job at the FDA, Sarepta Therapeutics shares jumped 25%.

As team leader, Farkas was responsible for digesting eteplirsen's phase 2 data and producing the briefing materials that were used by the FDA's advisory committee to make their recommendation against an early approval.

In those briefing documents, Farkas argued that the FDA needs to follow an order of operations that places efficacy ahead of an evaluation of a drug's benefit-to-risk profile. Sarepta Therapeutics bulls have argued that standard led committee members to focus too much on the phase 2 trial results and not enough on eteplirsen's relative safety and evidence of efficacy provided by patients at the committee's hearing.

I'm unsure how much of today's spike in share price is due to short covering (that information isn't available yet), but it wouldn't shock me if some of the 15.8 million shares changing hands today were bears buying in a scramble to unwind positions. Over the past three months, Sarepta Therapeutics' average daily trading volume is only 2.3 million shares.

It's anyone's guess if short covering will continue, but today's move should be considered in relation to eteplirsen's sales potential. Sarepta Therapeutics' market cap eclipses $1.5 billion now and that could be a bit high given that eteplirsen can only be used in about 13% of what is already a small patient population. 

Eteplirsen could haul in nine figures in revenue annually if it gets approval, but the range of sales could be in the low nine figures, not the high nine figures.

PTC Therapeutics' (PTCT 0.62%) Translarna, which isn't available in the U.S. but is available in the European Union, treats DMD patients in a way that's similar to eteplirsen. Translarna costs more than $300,000 per year, and PTC Therapeutics estimates it will generate sales of less than $90 million in 2016. Since the population of DMD patients in the EU is similar to the population in the U.S., Translarna may offer a hint at eteplirsen's future.

The EU is notoriously more hawkish on prices than the U.S., we don't know how much of a discount PTC Therapeutics is giving to individual EU member countries, and Translarna isn't available in every EU country yet, but even if we say that eteplirsen can bring in $200 million in sales, it would still mean that Sarepta Therapeutics is being valued at nearly 8 times revenue.

Of course, no one knows what's going to happen with eteplirsen. Farkas' exit may smooth a path to approval, but it doesn't guarantee it. Farkas wasn't the only one questioning eteplirsen's efficacy and the FDA has already rejected BioMarin's competing drug, drisapersen, which was evaluated in far more patients, and it's so far opted against reviewing Translarna for approval.

Overall, Sarepta Therapeutics' run-up today can't be ignored, but investors shouldn't race to conclusions that the shares will continue higher. An approval could lead to revenue soon, but sales aren't likely to trickle down to the bottom line for a while. Sarepta Therapeutics is spending $60 million per quarter on operating costs, and given that and the question marks associated with eteplirsen still, investors might be better off leaving this one to the speculators.