Short sellers have their eyes peeled on Vir Biotechnology (NASDAQ:VIR) and Sorrento Therapeutics (NASDAQ:SRNE). Short positions make up 22% and 26% of their float, respectively. Float refers to shares available for the general public to trade.

The immediate risk lies in the fact that so many investors are betting these stocks will decline. Another concern may be the possibility of a short squeeze -- followed by a big drop in share price. But the biggest risk of all for Vir and Sorrento is that their COVID-19 candidates are still in clinical trials.

Hand places block with RISK written on it on top of blocks reading HIGH, MEDIUM, and LOW.

Image source: Getty Images.

How do shorts work?

First, let's talk about short positions. Shorting happens when investors borrow stock now to sell at the market price. They then have to buy it back later to return to the lender. The goal is to buy it back at a cheaper price -- and therefore profit on the whole mechanism. A short squeeze happens when something drives the stock higher -- and those who shorted it scramble to buy back shares. That pushes the stock even higher. The trouble is, once that movement is over, it usually tumbles back down to earth. We recently saw that happen with GameStop (NYSE:GME).

Vir's potential line up

Now, let's look at where Vir and Sorrento stand when it comes to potential products.

Vir is working on three candidates for the treatment, and in some cases prevention, of COVID-19. The farthest along the trial process is VIR-7831. With partner GlaxoSmithKline (NYSE:GSK), Vir is studying this antibody treatment in two phase 3 clinical trials -- one for early outpatient treatment and another for the later treatment of hospitalized patients. VIR-7831 works by binding to a part of the coronavirus antigen, neutralizing the virus, and killing infected cells.

Vir and GlaxoSmithKline have partnered with Eli Lilly (NYSE:LLY) for another study. The companies are testing VIR-7831 paired with Lilly's antibody treatment in low-risk patients with mild to moderate illness. The U.S. Food and Drug Administration (FDA) already granted Lilly Emergency Use Authorization (EUA) for its antibody as a solo treatment.

Sorrento's longer list

Like Vir, Sorrento has several coronavirus candidates in the pipeline -- 11, to be exact. The candidates include potential diagnostics and treatments. Here, the furthest along are two diagnostics. The company has submitted an EUA request for one and plans to do so for the other. Coronavirus diagnostics is already a pretty crowded space. The FDA has already authorized more than 300 products developed by various companies and research centers.

I think Sorrento's most exciting COVID-19 candidates are in earlier-stage studies. The company recently announced positive results regarding its phase 1b trial of investigational stem cell treatment COVI-MSC for acute respiratory distress. All four patients treated with the candidate saw their conditions improve and were released from the hospital within a week.

There are two other interesting candidates. Sorrento is testing abivertinib in phase 2 trials for the reduction of coronavirus-induced inflammatory cytokine storms. Cytokine storms occur when the immune system spins out of control, and the body attacks its own cells. Sorrento is also aiming to start a phase 1 trial for COVI-DROPS, a neutralizing antibody nasal spray. This would be for the treatment of mild coronavirus cases.

Considering all of this, how risky are Vir and Sorrento?

I wouldn't worry too much about short positions. The outcomes of Vir's and Sorrento's COVID-19 programs represent more of a direct risk than the short situation. It's not unusual for companies participating in such a high-interest field to attract short-sellers. The short percent of Moderna's (NASDAQ:MRNA) float, for instance, rose to 10.4% in August of last year from about 6% in February. That occurred as investors bet on the prospects of its coronavirus vaccine program.

The development programs of Vir and Sorrento include interesting candidates. And so far, their data have been encouraging. In the case of Sorrento, one concern is that the company may have too many coronavirus candidates in the works. It might be better off focusing on the most promising. That said, the market prospects of one key candidate -- such as abivertinib -- could be big.

Vir, too, could score a big win for its revenue and share price with the potential authorization of one of its coronavirus candidates. But risk, too, remains big for these companies. Their share price movement is highly dependent on coronavirus news. And a stumble or complete failure in one of their trials could result in major share losses.

Still, I wouldn't look to short positions for clues about whether to avoid these biotech stocks. Instead, it's best to look at your own risk tolerance. If you're an aggressive investor looking for a company that may be one of the next winners in the coronavirus treatment competition, you might consider buying Vir or Sorrento shares. However, victory isn't guaranteed. So, if you're not comfortable with risk, you're better off watching from the sidelines -- at least until product candidates make their way closer to market.

This article represents the opinion of the writer(s), who may disagree with the "official" recommendation position of a Motley Fool premium advisory service. We're motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.