What Options Trading Signals For Arena Pharmaceuticals' Lorcaserin Safety Review (ARNA)

Business Week noted Arena Pharmaceuticals Inc. (NASDAQ:ARNA) as one of its three "Inside Wall Street" weekly stock picks this morning, and frankly it was the only pick with any sizzle to it.  Arena Pharmaceuticals will have a safety review of Lorcaserin, its lead drug candidate in Phase III for obesity, next month.  Business Week referred to two different reports.  It said that Fortisnotes that it could be a multi-billion drug, hence their $25 target.Needham also has a $23.00 target, although this drug may not hitshelves until 2010.

As far as when that safety review is in September is not yet known and has not been formally set.  I contacted David Walsey, Director of Corporate Communications at Arena, by phone this morning and he confirmed, "As of now no formal date has been set, but past guidance in the conference call is an indication for the month of September."

We wanted to see what stock options trading signals as far as price expectations and current trading activity ahead of the event.  We are including September stock options because the date is currently unspecified, but the bulk of the trading activity so far is for the October month option expirations.  For starters, Arena’s stock closed at $12.50 yesterday and have traded over $13.00 mid-morning.

The SEPT-2007 options are not that active with that month having a September 21, 2007 expiration date and some traders might not believe that the safety review will hit before then.  The September $12.50 Calls and $15.00 Calls have a small open interest with 1,285 contracts and 1,847 contracts listed in the open interest respectively.  But based upon current prices, it appears that options traders today peg only a $1.20 move based upon the safety review.  Traders should really rely the October expiration month for a clearer picture.

A review of the the October calls that expire on on October 19 is a bit more active and much more forthcoming: the $12.50 calls and the $15.00 calls each carry 5,788 and 6,641 contracts respectively in the open interest.  Combined that only represents 1.23 million shares on a fully leveraged basis, and the company trades 1 million shares or more on an average day.  When we look at the October contracts the price movement expectations we get a range of a range of up to $2.75 to $3.45 depending on which contract you use.  The put options for the $12.50 and $10.00 PUTS also have a combined open interest of 11,700 contracts and those price indications are somewhat in the same range.

We won’t make calculations out to January, 2008 contracts, but the open interest is even larger for the closest call and higher options there.  Keep in mind that these ‘option price indications’ can fluctuate wildly, and even though there is much time value these can go up and down based solely on options traders making price and risk adjustments.  Those figures are also based on a snapshot of mid-morning prices on a static basis rather than on a dynamic pricing model taking all historic trades and all strike prices into consideration.  With many investors being on vacation and half of Wall Street out all or most of next week, it’s probably safe to go ahead and make a forecast that this options trading activity and the open interest will increase considerably going into September.  With an $800 million market cap and some calling for this to be a blockbuster drug, Arena will probably garner a lot more outside press coverage ahead of and going into this event as well.

Here is the company’s description of the drug:  Lorcaserin, Arena’s orally administered, internally discovered drug candidate for the treatment of obesity, is in an ongoing Phase 3 program. The compound stimulates the 5-HT2C serotonin receptor, located in the hypothalamus, an area of the brain which helps regulate satiety and influences metabolic rate. Results from a Phase 2 study demonstrated that treatment with lorcaserin produced highly statistically significant, progressive and dose- dependent weight loss over a 12-week period. In the study, which excluded diet and exercise, patients taking a daily 20 mg dose of lorcaserin realized a mean weight loss of 7.9 pounds, while patients on placebo lost less than one pound. Lorcaserin was generally well tolerated at all doses and had no apparent effects on heart valves or pulmonary artery pressure.

Jon C. Ogg
August 24, 2007

Jon Ogg can be reached at [email protected]; he produces the 24/7 Wall St. Special Situation Investing Newsletter and he does not own securities in the companies he covers.