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The short interest on Arena (NASDAQ:ARNA) has been an interesting story for quite some time. While there are many that will consider a short squeeze a real possibility, the potential of one gets better when the days to cover the short position increase. With the latest short data, and thanks to lighter than average trading volume, the short story is once again getting interesting for savvy and active traders.

In the latest report, short interest actually went down while the days to cover increased. As stated, this dynamic is created by the recent low trading volume on Arena. Short interest went from 64.2 million shares to 62.3 million. The days to cover went from 9.08 to 16.76.

Regarding the short position, I am not a huge follower of the absolute number of shares short, but instead focus on the days to cover that position. The main reason I do not spend too much time and energy on the actual number of shares is because there are many short positions that are actually simple or complex hedging. These investment strategies can bet on volatility, lack of volatility, or even a specific trading range. While the short side of these trades may be upside down, the opposing side of the trade may not be.

I like to see the days to cover get above 10 before I begin to really focus on the dynamic. The more days it takes to cover the short position, the more likely a squeeze type action can carry a prolonged impact. Even at that, a short squeeze is simply an artificial run up in price, the opposite effect of a run down when short selling first happens. This is where the more savvy traders make money. The upward result of a squeeze will typically be over exaggerated and the equity will eventually settle down to more normalized levels. If that over-exaggeration is too pronounced, it can actually create a new level for short traders to play.

With Arena we have some issues in the pipeline that also deserve consideration. There is finalized DEA scheduling for the anti-obesity drug Belviq, as well as a decision on the drug in Europe. These factors can present upside pressure that makes the days to cover the short position a bit more compelling.

The opportunity here is that Arena is close to recent lows ($7.25) and well off of recent highs ($11.00). In my opinion, a decision by the DEA would be enough to get this equity to $8.50 as a baseline. If short covering gets thrown into the mix that number could push to $9.00. If a decision on Europe happens in a timely fashion, we could see another dollar or so pop and a baseline somewhere between $9.00 and $10.00. From there it is the sales figures that will determine the immediate future of the equity.

I see a tremendous opportunity for the long side at any price below $8.00 but also feel that caution is necessary as upside moves may take time, and as is often the case, timing can be an enemy. Regardless, a move to $8.50 is a pretty quick pop for the savvy in-and-out investor while positive traction can be beneficial for longer-term investors that have been patiently waiting the launch of Belviq. Essentially, there are some positive catalysts in the wings that align for both longer-term holders as well as traders. Stay tuned.

Source: Arena Short Story Getting Interesting