What's Behind the Volume Action of NASDAQ's Most Active Stock?

By Reza Ganjavi - June 25, 2012 | Tickers: ARNA, DNDN, PFE, RMBS | 0 Comments

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On Friday, for the second day in a row Arena Pharmaceuticals (NASDAQ: ARNA) topped NASDAQ's most active list, beating second in command Facebook by a whopping 20 million shares. It was the first day in 10 trading days that the stock closed down. While it is not at all unusual for a stock to close down one session in 11, investors who expected the 10-day streak to continue still ask themselves why. Added to the cause for speculation was the erratic move early in the trading session where the stock dived to $7.80 from a high of $11.99 and pre-market high of $12.40.

Pre-market action on June 22

Pre-market volume on Arena on June 22, after a 10-day rally, was 2,603,919 shares trading in the range of $11.60 to $12.40. The previous close price was $11.68.

The first 10 minutes

NASDAQ Times & Sales indicates an open of $11.96, followed by a buy of 477,076 shares at $11.99. The price came down a bit but at 9:35:29 it was still at $11.50 when a buy of 13,892 went through. Things seemed to be getting erratic when subsequent trades were going at wide deltas (e.g. back and forth between $11.11 to $11.50). Between 9:36 and 9:40 around 12 million shares changed hands -- the stock momentarily hit the low of day ($7.80) and rebounded quickly to $10.61 by 9:42 and $11.07 by 9:52.

Speculations

Speculations on what happened are abundant. Let's look at a few that were widely discussed:

1) A bear raid. Many investors speculate this was an orchestrated attack between some hedge funds and market makers to bring the stock down, to shock and awe the stock holders -- who are mostly retails as institutional ownership of this potentially blockbuster drug is measly -- and to take out stop-loss orders in order to help shorts cover. This theory gained support because many retail investors are showing huge gains and even selling at $7.80 would give them a nice profit, let alone at $11. Such a tactic would certainly prompt some retail investors to throw in the towel, take the profit, and hand over their shares at a discount to shorts who need to cover and institutions who want to buy.

2) It is conceivable that the selling of a few million shares in the first 10 minutes was simply profit taking. I personally know that some retail investors have more than 1 million shares. So it's possible that there was no conspiracy or bear-raid and simply profit taking but highly unlikely because institutional and large holders who want to sell almost always drip sell in order to get the best price and never kill the bid like it happened in this case, unless there's panic selling due to bad news. That wasn't the case here.

News Coverage

Being Nasdaq's most active stock two days in a row attracts a lot of news coverage and tweets. Going through these items it became evident to me that most people who wrote articles about Arena have no deep insights into the market opportunity and positioning, let alone the science.  An analyst was quoted by a news source in which he speculated the recent rally in Arena shares is all due to retail investors. This can't be farther from truth. Retail investors don't give a stock 80-million day volumes.

Speculations on what happened are abundant. I might add some ideas in the comments section if readers are interested.

Recap of Key Facts

In light of all the "noise" around a most-actively-traded stock, it is important for investors to keep in mind the following facts about Arena:

1) The obesity market is huge, and underserved. Obesity is an epidemic and the number one killer (it's surpassed smoking). Hundreds of billions of dollars are spent on treating obesity-related diseases in the US, and much more worldwide.

2) Lorcaserin is the safest of all three drugs in the pipeline and doctors view safety as extremely important when it comes to obesity medication.

3) Lorcaserin works very well. Of those completing the studies, 63.9% lost greater than 5% of their weight, 34.7% lost greater than 10% of their weight, and the top 25% lost over 16.7%. The average completer weight loss was 26 pounds or 8.2%. It has been scientifically proven that even a 5% drop in weight can result in important health improvements.

4) Lorcaserin significantly lowers blood glucose levels in type 2 diabetics.

5) Arena has a huge short interest, which bet against a positive AdComm and approval. So far they were wrong about the outcome of the AdComm and they know approval is coming so that's one wave of demand. History shows big shorts become big longs. So this is double demand.

6) Institutional ownership is very low and with new analyst coverage and upgrade post-approval, this will be another huge wave of demand for shares.

7) The company has a strategic partnership with Eisai, its own manufacturing, and is ready to hit the ground running.

8) Many other catalysts for the stock will put the fair target well above $20 per share with an acquisition target of $50. Sierra World Equity Review believes Pfizer Inc. (NYSE: PFE) is looking at acquiring Arena. In another published note, it also predicts the stock to "take off like a rocket again this week after approval leading to an amazing July for all the shareholders."

9) Approval on or before June 27 is very likely. Worst case scenario is a three-month delay so it's important to not be on margin.

Michael Murphy's Take

Analyst Michael Murphy has the most accurate assessment of the situation out of all the postings and articles I've read. In a note to his subscribers he reminded them that no large holder would just dump shares like we saw happen on the open -- it was done to take out the stops and buy at bottom but they weren't that successful [summarized]:

"They gave it their best shot and traded 89 million shares for the day, but could not knock the stock intraday below where it closed eight trading days ago... three days ago... and closed all the gaps back to June 12 without being able to close the stock under any of them but Thursday's. That's actually a very weak performance."

Conclusions

Most investors conclude from Friday's action that the market thinks Lorcaserin will get approved. However, most believe something manipulative, inappropriate or illegal happened. Where's the SEC in all this? Most people who saw the manipulation in Dendreon (NASDAQ: DNDN) are wary in reporting anything to the SEC because of the perceived inaction. Nevertheless, several letters to SEC have been written. My letter to the SEC can be found here.

A couple of investors reflect:

"When all else fails and your short position is in deep, and the hedge funds have the necessary tools in place to drop 20 million shares or whatever the amount necessary to trigger the stops and shake the weak hands out of their shares. The panic to exit their short position should give the longs confidence that good news is expected. I have experienced the raid a couple of times with Rambus (NASDAQ: RMBS) and watched from the sidelines on Dendreon and in each case (if my memory is correct) the stock not only recovered but made new highs."

"The crooks pulled a bear raid on us today, no doubt about it. The end goal has not changed, Lorq gets approved on the 27th. I was fuming this morning watching the PPS head south because of a bunch of criminals who didn't have the foresight to get in on this stock a long time ago...so instead they just manipulated the market after it took off so they could get in cheap after they missed the boat... They won the battle today, but THEY WILL NOT WIN THE WAR! We are going to see ARNA valued at what it's worth in the very near future. I did not sell one single share and will not sell any shares until we are in the $30s."

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