Should Investors Worry About Arena's Short Interest?

| About: Arena Pharmaceuticals, (ARNA)
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Over the years I have often seen debates about the short interest in stocks. Discussion about the subject seems to always drift to overt manipulation, conspiracies, and "illegal" naked shorting. What I always find interesting is that those who subscribe to such theories never complain if they are on the right side of the trade. In other words, when an equity runs, it is never being manipulated to do so. Instead it is finally "doing what it was supposed to do long ago."

The fact of the matter is that there are two sides to a market, short and long. The market is also full of traders that play both sides and use the market as a tool for income rather than what we might call a classical investment.

Currently the short interest in Arena (NASDAQ:ARNA) sits at 61.7 million shares. This is the highest the short interest has been all year, but in many ways the number is not material. When looking at the short side of the equation it is the "Days To Cover" that matters.

Days To Cover takes into account how many trading days it would take to cover the short position. With Arena the Days To Cover is at 6.5. That is not a very long period of time, and certainly not enough to set up a short squeeze that will propel an equity for any length of time.

For the past couple of months Arena has traded between about $7.25 and $10. It will likely continue in that range until such time that the DEA assigns a schedule to the company's anti-obesity drug Belviq. Essentially traders have a security blanket in the lack of DEA news. Even when the DEA news is released, traders have time to react and adjust strategies.

In my opinion the current short position is nothing to worry about, but further, is not large enough to compel a short squeeze either. What I typically look for is something in the neighborhood of 10 Days To Cover. What we need to understand is that as an equity gains in popularity and volume, it gains more active traders as well. There is usually a "natural" short position in any equity and there are scads of trading strategies that could employ a short position.

The lesson here is that while the number of the short interest seems to be high, the average volume is as well. What we should do is note is that the Days To Cover has increased in the past few reporting periods. This should place a blip on your radar screen, but is not really cause for alarm or excitement. Strategically an investor will want to see if the Days To Cover approaches 8 in the next report. If that happens, a valid and timely discussion can begin to take shape with meaningful data rather than just a whim.

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.