The Medicines Company's Flag Formation Puts Pressure on Short Sellers

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Pharmaceutical concern The Medicines Company ( MDCO ) has made headlines in recent weeks, as the company battles to extend a patent on its anti-clotting drug Angiomax. On Sept. 10, the company announced that a U.S. district court had denied APP Pharmaceuticals' appeal against the patent extension. The news sent the shares soaring more than 19% as a result, with MDCO settling into a trading range between the $14 and $15 levels.

As you can see from the chart below, the stock's price action has created a flag formation. This technical pattern typically results in a continuation of the stock's former uptrend, and is characterized by a sharp rally -- a flag "pole" -- and a period of consolidation -- the "flag" itself. In this case, the continuation of MDCO's former rally would result in a breakout above the $15 level, sending the shares sharply higher as a result.

Daily chart of MDCO with flag formation

In the event that this flag formation resolves itself to the upside, an unwinding of the wealth of negativity levied against the shares could intensify MDCO's resulting rally. For instance, options traders have rarely been more bearishly aligned on the stock, with its Schaeffer's put/call open interest ratio (SOIR) of 1.21 arriving just one percentage point shy of an annual peak. An unwinding of these negative positions could create a tailwind for MDCO.

Meanwhile, data from the International Securities Exchange (ISE) and Chicago Board Options Exchange ( CBOE ) point toward a rising preference for call buying. During the prior two weeks, some 33 calls have been bought to open for every one put purchased on MDCO. However, whether this call buying is bullish speculation or hedging activity remains to be seen.

Speaking of which, short sellers have reason to be considerably nervous about a sharp rally. During the past month, these bearish traders have loaded up on MDCO shares, increasing short interest by nearly 7%. As a result, roughly 9% of the stock's float is now sold short. If the flag formation does resolve to the upside, these short sellers could be forced into a short-squeeze situation.

Short interest chart for MDCO

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This article appears in: Investing , Options

Referenced Stocks: CBOE , MDCO

Schaeffer's Investment Research

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