During weekly study visits patients will undergo breath carbon-monoxide and breath alcohol testing, and they will answer questions about depression, smoking and alcohol use. Detailed assessment of psychiatric symptom severity (including neuropsychological testing) will be performed at baseline, at the end of the treatment phase (week 8). A functional MRI study will be performed at baseline and at the end of study to assess changes in blood flow, emotional processing and working memory related to varenicline treatment. In addition, genetic polymorphism of the α4β2 nicotinic acetylcholine receptor and gene expression changes related to drinking/smoking/psychosis and varenicline treatment will also be assessed.