Arena Short Interest Declines - So Do Hopes Of A Squeeze

| About: Arena Pharmaceuticals, (ARNA)
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I see it time and time again. Investors in a company become pretty passionate about it and look for almost anything that will cause the equity to rise above current levels. I oft see discussion of the short interest in an equity and how "evil" those short players are.

The fact is that almost any equity can have a short position for any number of reasons. Sometimes it is as simple as an investor believing that the equity will go down, and sometimes it is more complex involving an equity play as well as an options play.

In the most recent short interest report the data shows that there are 52,590,549 shares short for Arena Pharmaceuticals (NASDAQ:ARNA). This is down from a 56,790,816 shares just two weeks prior. Since FDA approval of the anti-obesity drug Belviq, Arena's short interest has been as low as 39 million shares and as high as 61 million. While it may appear to be a big number, 52 million shares short is actually pretty normal. Personally, I rarely care about what the actual short number is. I like to focus on the days to cover.

Days to cover represents how many days it would take to clear out the short position given the volume the equity is trading at. If you think about the concept of a short squeeze, it requires a heavy short position and pressure applied over time to have the equity rise on the heels of the shorts trying to buy back in to cover their short position. If it only takes two days to cover the short position it becomes difficult for the squeeze to have any strength.

In many communications from readers, I have stated that I don't really sweat the short interest unless it gets to 10 days to cover. In my opinion, 10 days is long enough to make a more meaningful squeeze.

As the holidays of 2012 approached, the days to cover the short interest in Arena rose to over 12. This happened because trade volume on Arena, and the market as a whole, evaporated. People were on vacation, traveling, or otherwise busy with other things. When the holidays come, the numbers can skew. With days to cover above my threshold of 10, I suddenly got scads of emails and text messages about a possible squeeze setting up. I had to be gentle in reminding readers that the holidays throw in a different dynamic. As stated, trading during that period is light, and thus the days to cover would get bigger even if the actual shares remained the same. My advice was to wait and see what the days to cover is when trade volume normalizes. Well, we have that day now.

The new data shows that the days to cover the short position is at 6.45. Essentially, the short interest went down about 7% while the days to cover dropped almost 50%. Normal volume is the answer here. Perhaps 6 days to cover is enough for a mini squeeze, but in my opinion, we are seeing more normalized activity now, and a big squeeze is simply not on the menu.

If you are bullish on Arena you likely feel that shorts are crazy. Remember, there are many trades that are designed to lock in an arbitrage between the equity price, the most likely action, and options prices. While I am not one that typically shorts any equity, I do understand why a natural short position can and will exist in any equity. Being short, the equity does not always equate to a bearish outlook.

My advice is not to worry about the short side. Worry about company performance, news, and financials.

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.