Arena Short Interest Remains Interesting

| About: Arena Pharmaceuticals, (ARNA)

The short interest in Arena (NASDAQ:ARNA) remains an interesting metric to watch. As an investor, I do not put too much stock in the short interest unless it gets above 10 days to cover. Days to cover is essentially the short interest in shares divided by the average daily volume. Arena short interest now stands at 61 million shares with the days to cover at 11.64. This represents a month now that this equity has remained above 10 days to cover.

The reason I use 10 days as a barometer is because that length of time can create a meaningful move in the stock should a squeeze begin. When news happens, or an equity moves, it is not unheard of for volume to be twice the normal rate. If a squeeze can last 5 days, there is a decent shot that a meaningful move can happen and a savvy investor can benefit.

One key in playing a squeeze is to understand that the move upward on a squeeze is just as artificial as a move down when shorting an equity become the move de jure. These artificial swings can create profitable trades for a savvy investor. Throw other catalysts into the mix and things can get really exciting. However, like a roller-coaster ride, the thrill ends rather quickly. That is exactly why you need to be savvy.

With Arena, there is a very interesting dynamic at play. Throw away the conspiracy theories and simply work with what is known. There is indeed a popular sentiment that Arena is a great stock to short. That sentiment is countered by an undercurrent that the company has potential, and while blockbuster status may be years away, that the near term could prove successful enough to warrant current prices.

Arena is perhaps days away from launching its anti-obesity drug Belviq. There is a lot riding on getting the drug to the market, and even more riding on the initial sales numbers delivered by the company itself or channel checks. While most have their eyes on the launch, the real story develops with the initial sales numbers.

In my opinion Arena is not going to hit a home run coming out of the gate. I feel the company will deliver good sales numbers, but will be short of what could be labeled as a blockbuster in the making. Blockbuster status is at least a year away. The key in my opinion is that Belviq has to pace at least 3 times above what Vivus did with Qsymia. In my opinion, it would take first month Belviq sales numbers of at least 15,000 to silence the short side of this equation. Anything less and the current battle can continue.

One common misconception that I frequently see and receive e-mails about is that the shorts in Arena are under water and have been for quite some time. This may or may not be true. First, there are trading strategies that utilize a short position as a hedge. Such trades sometime capitalize on volatility or an equity moving within a specified range. The other thing to consider is that when a short sale happens, the seller gets cash. Consider this. What if a person shorted Arena at $7 and bought another equity with that money at $7? Arena is now at $8 and the other equity is at $12. The trader is not under water at all, but in fact is in a very profitable position. The short is only under water if the money garnered from entering the short position is making less than the delta from initiating the short to the current price. In addition, Arena has been a ranging stock. It would not be unheard of for a short to cover, wait for a run and then short again.

With the launch of Belviq around the corner, investors will need to pay attention. I fully expect heavy volume when the launch is announced. I expect heavy volume when sales figures are released. Extremely heavy volume could mean that shorts are indeed closing positions. This is where being savvy can mean profits. It is not unheard of for a short squeeze to top out and then a sell-off to follow. This sell-off can be a factor of profit taking for longs trying to catch a top, and new short selling in hopes of gaining back a winning position. As an investor, you simply need to pay attention. What you want to watch for is moves on volume.

In my opinion, the launch news can allow this equity to perhaps test $9 and then settle down awaiting the real news. The real news is initial sales results. Good sales and the equity can build past $9 and perhaps begin to test $10. Great sales could see this equity test recent highs of $11.00 and beyond. Stay tuned, this will get interesting quickly.

Disclosure: I am long ARNA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.