Insanity struck pharmaceutical stocks this past week. Specifically, the short seller killing moonshot in KaloBios Pharmaceuticals (KBIO). Unless you’re a drug stock junkie you’ve probably never heard of KBIO – I certainly hadn’t. But when I came across the following article from Business Insider I thought I’d pass it along with a few thoughts.

1

If you’ve ever wondered why you hear veteran traders and mentors parrot the advice “don’t do drugs”, well, wonder no longer. The debacle of a trade put on by the poor shmuck is a perfect example of the risky road that gamblers must trod when playing small drug stocks. The nature of binary events like FDA announcements and other such news that strikes pharmaceuticals on a regular basis virtually guarantees your success or failure is based purely on luck.

And relying on luck, in case you were wondering, it’s a horrible, horrible idea. For bad luck is doled out just as frequently as good luck. It’s not a game you want to play.

2

Selling short really does have unlimited risk. If you buy a $2 stock you can only lose $2, but if you short it you can lose infinity as poor Joe is finding out. In reality you, the reckless trader, lose everything in your account and the broker is on the hook for the rest. Which is why it’s interesting that E-Trade let the guy short that many shares (assuming he’s not lying, of course). In ThinkorSwim you can’t short shares of KBIO even if you wanted to. As shown in the graphic below there is “NTB” or none-to-borrow.

3

If you are going to sell short, do you really want to choose a $2 pharmaceutical stock? C’mon, man use your common sense. If it were me I would have first looked and seen that it was a small drug stock (boo!) and then identified its $2 price tag (double boo!) and went on my merry way.

4

If you’re intent on rolling the dice on one of these types of stocks then for heavens sakes at least use a limited risk option play like a bear put spread. If, like in the case of KBIO, options aren’t available then move on to greener pastures. Since there are so many opportunities that arise on a daily basis in liquid markets why would you ever bother with a stock like KBIO? It’s mental.

I’m certainly not trying to beat-up on the poor guy. Look, ignorance abounds on Wall Street. The masses make idiotic missteps on a daily basis. But this one might well take the cake. Plus, I would be remiss if I didn’t at least point out the lessons worth taking away from this whole debacle.

It’s worth adding not all drug stocks belong on the no-no list. If it’s a massive company like Pfizer or Merck with drugs galore in the pipeline then the risk of one bad FDA announcement derailing the stock is minimal. They’re just too diversified.

In parting, here’s the chart of KBIO. Redonkulous, I know.

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