Arena Pharmaceuticals, Inc. (ARNA) has had a fantastic run since it received approval for Belviq, its anti-obesity drug. Though it faces competition from Vivus (VVUS) which also received approval for Qsymia, another anti-obesity drug, the prospective market is rather large and enough to support a few players. Bloomberg states that 42% of all Americans will be obese by 2030, so this is certainly good news for anti-obesity drug manufactures and clearly indicates that this market will be large enough to support more than one player.
Even though Qsymia has been shown to be more effective than Belviq, Arena's stock has performed better to date. The 52 week change in price for Arena's shares is 553% vs 187% for Vivus shares. This does not mean that Vivus is not a good play. It could simply be that investors have so far failed to realize the potential its two recently approved drugs Stendra and Qsymia hold. According to Rodham & Renshaw sales for Qsymia could hit $42 million this year and $290 million by next year.
On the other hand, the strong showing in Arena indicates that investors are confident that there is enough room for several players to thrive as the market for anti-obesity drugs is huge.
The strategy of selling a put to purchase calls provides bulls with a great opportunity to leverage their position in Arena Pharmaceuticals, Inc. but it also provides one with the chance to get into the stock at a much lower price. Only put this strategy to use if you are bullish on the prospects of this stock as there is a chance that the shares could be put to your account.
It has almost completed a 50% retracement in price. It traded as high as 13.50 and dropped down to 6.95 before trending higher. The 6.95-7.05 ranges (former resistance turned into support) should serve as floor in terms of price as this zone offers pretty strong support. It is also trading outside the -1 standard deviation Bollinger band. Normally, the next step for a stock is to trend sideways before it breaks out and this is what appears to be taking place. The same pattern occurs when a stock trade above the +1 standard deviation Bollinger band as indicated clearly in the above chart. There is a chance that the stock could test the 7.00 ranges again before taking off. This is a volatile stock and when it starts to move, it usually moves in a very rapid manner.
Suggested Strategy for Arena Pharmaceuticals, Inc.
This play has two parts to it. The first part entails selling a put and in the second part calls are purchased with the proceeds from part 1.
The Jan 2014, 7.00 puts are trading in the $ 2.45-$2.49 ranges. The markets are in a volatile state right now and appear to be consolidating. Furthermore this is a volatile stock, so there is a good chance that this stock could test its recent lows before taking off. If the stock pulls back to the $7.00-$7.50 ranges, these puts should trade in the $3.00-$3.20 ranges. For this example we will assume that the puts can be sold at $3.00 or better. The premium obtained from the sales of the puts will be used to complete the second part of the trade.
The Jan 2013, 12.50 calls are trading in the $0.71-$0.75 ranges. If the stock pulls back to the stated ranges these calls should trade in the $0.40-$0.50 ranges. We will assume that the calls can be purchased at $0.50 or better. You will be able to purchase up to 6 calls for each put sold.
Benefits of this strategy
You have an opportunity to significantly leverage your position in this stock for a relatively low cost. If the stock should take off, or even come close to testing its recent highs, these options could soar in value. Additionally the cost is rather low. You only need to put up $700 to secure the put, but you would be in a position to control up to 600 shares. You would need to put up roughly $5200 if you bought 600 shares at the current price.
If the stock trades below the strike price you sold the puts at, the shares could be assigned to your account (assignment usually occurs on the last trading day of the option). Depending on the number of calls you purchased your cost per share could range from $4.50 (if you purchased one call only) to $7.00 (if you purchased six calls).
As long as you are bullish on the stock, the possibility of having the shares assigned to your account should not be an issue, as this strategy provides you with the chance to get into this stock at a lower price. The only real risk is that you have a change of heart and you feel that the stock could trade well below the strike price you sold the puts at. In this case, you could roll the put. Buy back the old puts and sell new out of the money puts.
While the trend is still up the markets are in a volatile phase. Consider closing half the position out if the calls are showing gains in the 60%-100% ranges. Alternatively, you can sell half if and when the stock trades to 10.50-11 ranges and then risk holding the other half until it tests its old highs or trades to new highs.
Options tables sourced from yahoofinance.com. Option Profit loss graph sourced from poweropt.com.
It is imperative that you do your due diligence and then determine if the above strategy meets with your risk tolerance levels. The Latin maxim caveat emptor applies - let the buyer beware.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Additional disclosure: This article was prepared for Tactical Investor by one of our analysts. We have not received any compensation for expressing the recommendations in this article. We have no business relationships with any of the companies mentioned in this article.