Over the last few years, retail traders who refer to themselves as apes have been targeting various "meme" stocks with high short interest such as GameStop Corp. (GME), AMC Entertainment Holdings, Inc. (AMC) and Bed Bath & Beyond Inc. (BBBY) in an effort to create a short squeeze. They have had varying degrees of success, though these stocks have pulled back significantly from their 2021 highs. Attempts to change the system have largely failed, though meme stock traders did manage to collapse one multi-billion dollar hedge fund in Melvin Capital. Scilex Holding Company (SCLX) is the latest meme stock gaining some traction, and in our opinion this unique situation has the best chance of creating a massive short squeeze over the next month. If you like our picks you can follow this blog by clicking the follow button on the top of the left hand panel. We have 1014 followers on here as well as 120 followers on our Canadian blog. You can also follow us on Twitter @StockTradePicks which has over 5,000 followers.
SCLX was a spinout of Sorrento Therapeutics, Inc. (SRNEQ), a polarizing and heavily-shorted company that has had many ups and downs through its trading history. Sorrento somewhat voluntarily went through the bankruptcy process post-spinout, presumably in an attempt to get a court-order account of the shares in SCLX. It might be working. This article provides a brief history of the situation between SRNEQ and SCLX, as well as the theory behind the short squeeze. While SCLX's float on Yahoo Finance is reported to be 85 million, that actually isn't true. The vast majority of these shares are locked up until May 11, with the actual float being in the two million range. There is another six million or so warrants (SCLXW) with a strike price of $11.50, but over a million of those have been purchased by Sorrento on the open market.
At the time of the spinout, there were around 60 million shares short of SRNE. This translated to 8.5 million SCLX shares short, all of which have the same lockup restrictions as the long shares, except that cost to borrow and margin requirements still apply. There aren't enough shares and warrants currently in the market to allow shorts to hedge. If brokers force the closure and margin calls of these positions before the May 11 hold period, the owners of the tradeable stock and warrants hold all the cards. They can set the price at which they want to sell. This of course only applies to reported shorts. It doesn't account for naked shorts, which if you believe the meme stock narrative, would be multiples higher of reported short interest.
Sorrento and Scilex are working hard to account for and stimulate the need to close off the short positions. As part of the bankruptcy proceedings, the companies got a court order for the top 25 brokers in the United States to provide a full ownership report of SCLX shares to Sorrento. Out of the 76 million shares issues, so far 44 million have not been reported. SCLX delayed its AGM from April 6th to 17th in order to give time for the brokers to account for the discrepancy.
One blogger speculates that this has been an intricate plan by Sorrento to force the covering of shorts. Sorrento having purchased some SCLXW warrants on the open market in addition to the massive SCLX holding it has could be a sign that the company is trying to profit from a short squeeze as well as exacerbate the situation for the shorts by reducing the availability of SCLX securities on the open market.
The trading this past week has indicated that this is starting to work. SCLX usually trades a little over 100,000 shares in a day. But on Wednesday it traded nearly 12 million shares and shot up 57% from $7.92 to $12.40 while hitting a high of $16.90. That was followed up by a 4% increase on Thursday to $12.90 on 3.4 million shares. The stock opened at $10.20 but rose throughout the afternoon. That looked like typical naked short selling tactics to hit stop losses then cover throughout the day. No doubt that some shares have been purchased to hedge any restricted short position, while others are being flipped multiple times a day. But as we have already discussed, the free floating securities are less than the actual short position and potentially way less than any unreported naked short position. There may be unlimited demand from shorts needing to hedge their position. Especially if the price keeps going up and brokers increase margin requirements or force margin calls.
This is sort of like the Meta Materials Inc. (MMAT) and MMTLP situation, except brokers can't merely settle any outstanding SCLX short position at closing value like they did with MMTLP. These shares are going in the opposite direction of MMTLP, from restricted or private hands into the public market. There is also a court order demanding reporting of any shareholder ownership, of which any excess beyond the 76 million would be implied to be borrowed or synthetically made in order to short. No matter how hard retail traders tried to make other stocks pop off, they never managed to get a court order demanding the accounting of all shares quite like this. This is unchartered territory for the short squeeze thesis.
We have bought the SCLXW warrants. Why the warrants? Simple, a bullish bet with the maximum upside potential. If the stock goes to $20 - a 55% increase from Thursday's close - the warrants are worth at least $8.50 - a 232% increase from Thursday's close.
Disclosure: We are long SCLXW
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