Elanco Animal Health Inc. (ELAN) shares shorted more than quadrupled in 2019, increasing by 40.3 million shares, and increased by 8.2 million shares over the last week, +20%, but shorts will probably be forced to cover some of their outstanding positions over the next few days as we are seeing a tsunami of recalls hitting the street today. Over 9 million shares of ELAN stock were recalled today and with minimal amount of lendable stock left on the street, shorts will have to close out some of their positions in order to satisfy their outstanding recall requests. In addition to ELAN short selling, we are also seeing increased Eli Lilly & Co (LLY) short selling as well, with shares shorted more than doubling over the last two weeks, increasing by 40.2 million shares to 75.4 million shares shorted.
Elan Animal Health Inc (ELAN) short interest is $1.54 billion; 49.63 million shares shorted; 68.76% of float; 19.15% borrow fee on existing shorts and 30% to 60% fee on new shorts.
We can expect a large amount of short side buying to give a positive boost to ELANās stock price this week. Coupled with the fact that March 8th is the last day for Eli Lilly (ELY) shareholders to voluntarily exchange their shares for ELAN stock, we can expect a significant increase in volatility in ELAN shares this week.
At the moment, the offer of 1 share of LLY stock in exchange for 4.5262 shares of ELAN stock (upper limit of the ratio) creates an arbitrage profit of just under $12, net of financing, for every share of LLY exchanged:
-1 share LLY @ $126.31/share + 4.5262 shares of ELAN @ $30.61/share ā 1 week of short ELAN stock borrow cost = Arb P\L
In late morning trading, the Arb P\L would be:Ā -$126.31 + $138.55 – $0.34 = +$11.90/share profit.
If the short covering from the recalls pushes up ELANās stock price significantly we can see the Arb profits get even richer, although there is the risk that LLY adjusts the ratio of the exchange and negatively affect the arbitrage P\L.
Unfortunately, with ELANās stock borrow getting tighter and tighter, it may be difficult or virtually impossible to get into this arb trade in size via normal short selling.
In lieu of shorting ELAN stock, we are seeing active option activity in the 40 strike ELAN calls and puts which creates a synthetic short using a long put/short call collar. The synthetic ELAN short will be used to offset the long ELAN shares which will result in the exchange of LLY shares. There were over 60,000 contracts of these 40 strike collars executed last Friday and over 12,500 contracts executed today.
With short recalls in ELAN, increased short activity in LLY, active arbitrage trading prior to this weekās exchange date and active option activity to create synthetic ELAN shorts, volatility in both ELAN and LLY and the probability of sudden and material price swings should be high this week.
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Managing Director Predictive Analytics, S3 Partners, LLC
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