Arena Pharmaceutical (ARNA) is a small capper, clinical stage biopharmaceutical facing a decision by the FDA today (PDUFA date) regarding its weight loss drug Lorcaserin. The closely-watched event has been unfolding the past few weeks with favor towards the company’s shares. In fact, ARNA has traded up about 500% in just three months from about $2 in late March to its recent and ultra-volatile high of $11.99 back on Friday where its trading range was about 35% from high to low and closer to 75% with its wild intraday price swings. Tuesday’s close found shares off a rather tame 3.70% to 8.88 in front of the event to be announced sometime intraday.
Reading the boards and various blogs and the takeaway is smaller investors see big things for Lorcaserin and ARNA shares than Street analysts. Though the latter also by and large tend to see the outfit receiving approval for its drug in its second attempt in front of the FDA, some concern of risks with the drug itself and competition from the likes of Vivus (VVUS) with its Qnexa, reflect somewhat modest sounding sales estimates in the $1.0 billion neighborhood in the next few years to possibly $2.0 by decade’s end and immediate price targets in the area or “arena” of $6 for bears to $11 for the most bullish of calls.
Figure 1: Arena (ARNA) Monthly Chart
As discussed, shares of ARNA have been on a technical tear in anticipation of Wednesday’s PDUFA date and approval for Lorcaserin. The monthly chart in Figure 1 sums up the enthusiasm well enough as shares have taken out the highs near $8 in mid-2010 when the company first sought approval for the drug and held those levels after breaking above that level of resistance.
Closer in detail of the action from Friday’s fore-described volatile session, which narrowly etched out new intermediate highs of $11.99, did manage to find support at the prior highs, backed up by a Fibonacci retracement of 38% for its three month cycle run.
For the bears, Monday’s volatile daily hammer appears significant as it marks a key low in ARNA’s uptrend. That said, the 50% level comes in near $6.80 and right near the highs of early May’s bullish gap spike which resulted in about a month of consolidation work. A retracement of 62% comes in near the lows of that technical congestion, 50SMA support and the low-end of Street price target estimates culled for this report.
Immediately in front of today’s report, Tuesday’s option trading saw calls favored by an unsurprising and none-too-dramatic 2.50-to-1.0 margin over puts. Volume has been through the roof in recent weeks with Arena typically in or near the top spot for unusual activity within the Russell 2000 and option volume clearing upwards of 200,000 on select days and seeing base 50SMA activity of about 36,000.
Most active on Tuesday, the out, but near-the-money July 10 call traded about 11,400 contracts. With open interest of 24,000 and more importantly, frenetic trading conditions and one point strike availability, as well as June Weeklys available; it’s impossible to say for sure what the other trader may have been doing with that particular very well-bid call. Nonetheless, priced at $1.90, a double to $3.80 by expiration would require a move north of 55% in shares to $13.80 which eclipses the most recent bout of technical optimism at $11.99 and fore-mentioned analyst opinion of $11 a share.
Figure 2: Arena (ARNA) Total Volume Levels
“Sell 100 and Buy 200!!??” There’s a less popular saying on Wall Street which we pull out on occasion which refers to fading spikes in implied volatility, but only up to a certain juicy threshold. If premiums continue to receive an over-the-top bid, like the arbitrary 200% level, then all bets are off the table or closed out and the trader might consider going long the rich juice in anticipation that it’s not going to be business as usual, but more of an outlier, exception to the rule.
Personally, we hope Tuesday’s most popular contract acted as a hedge or was hedged by other richly-priced premium despite the July ATMs trading around 270% IV and not to mention the roughly 700% IV established in its June Weeklys which expire in two sessions.
Theoretically, the latter bid suggests traders expect, a 1SD or 68% chance ARNA will remain within approximately 64% of Tuesday’s close or between $3.25 and $14.50 through Friday’s expiration for the Weeklys contract. At the same time, a simpler but obviously risky hedge free break-even of $4.5 and $13.5 is the bi-product of the ATM June 9 straddle market but one which also, in our mind, stresses thinking seriously about trimming the fat before a definite, but potentially toxic drop in premiums is the Rx of the day.
Disclaimer: Analyst maintains an adjusted and currently, rather neutral collar in ARNA shares.
Senior Options Writer, former Market Maker & fulltime Option Hedge Hog Advocate
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