As my readers know, gold and silver have been struggling since the year began, adding to the decline from the highs in the fall of 2012. In the last 6 months, the SPDR Gold Trust (GLD) and the iShares Silver Trust (SLV), the two most popular ETFs that track spot gold and silver prices, are down 8.0% and 12.0% respectively. The gold and silver miners, as measured by the Gold Miners Index (GDX), the Junior Gold Miners Index (GDXJ) and the Global X Silver Miners (SIL) have been hammered in the same time frame, down 23.8%, 30.0% and 17.9% respectively. One of the best trading vehicles for short to medium-terms upside moves in the miners, the Direxion 3X Gold Miner Bull ETF (NUGT), has seen an incredible 60% loss in just 6 months. As such, Direxion, a leader in providing popular leverage bull and bear funds, announced on March 1, 2013 it will execute a reverse share split of NUGT, which aims to provide a return 300% that of the gold miners index. While other leveraged bearish and volatility funds have reverse split in the past few months as the 4 year bull market continues to power higher, such as the 1 for 4 reverse split of the iPath S&P 500 VIX Short-Term Futures ETN (VXX), NUGT is essentially alone as a bull fund to need a reverse split. Highlighting the problems the stocks in the gold mining space have had, Direxion believes that its post-split investment prices will be more attractive for buyers.
No other gold mining index will be affected by this split, such as GDX or GDXJ, but some of Direxion's other products will be adjusted as well, which are detailed here. The reverse split will be conducted at a ratio of 1 for 5 and will apply to shareholders of record at the close of the markets on April 1, 2013, and will begin trading at the adjusted price April 2, 2013. The ticker symbol for the fund will not change. The reverse split will increase the price per share of the fund with a proportionate decrease in the number of shares outstanding. In a 1 for 5 reverse split, every five pre-split shares held by a shareholder will result in the receipt of one post-split share, which will be priced five times higher than the value of the pre-split share. The following example best illustrates what to expect: If you hold 1000 shares of NUGT priced at $5.00 each, then after the reverse split you will hold 200 shares valued at $25.00 each. As you can see, the reverse split does not change the value of a shareholder's investment, it still remains $5,000.
Shareholders who have quantities of shares that are not a whole number with an exact multiple of the reverse split ratio will be left with what is known as a fractional share. A fractional share will be created and affect any shareholder who does not hold a number of shares that is a multiple of five. After the reverse split occurs, fractional shares will be redeemed for cash and sent to your broker of record, generally within two to three weeks post-split. One issue to consider in this event is that redemption of fractional shares forces shareholders to realize either gains or losses, which could result in a taxable event in addition to having a potential loss on investment if prices are below where they were purchased. Given that the gold and silver markets are near 6 months lows and the miners are still forming a bottom, a loss is a strong possibility with NUGT. To avoid this scenario, investors can purchase more shares to round out their NUGT holdings to a multiple of five, or to sell an appropriate number of shares to round out the holdings.
Options contracts are an important consideration as well. Traders who may be holding options on NUGT should realize that this split will affect your contract(s), albeit minimally. Once Direxion conducts the reverse split, the contract undergoes an adjustment referred to as "being made whole." When contracts are adjusted to be "made whole", it simply means that the option contract is modified accordingly so that options holders are neither negatively nor positively affected by the split. While we know the reverse split will adjust the price of the underlying shares of the NUGT options, the options will be adjusted so that the changes in price due to the split do not affect the value of the options. The options clearing corporation will automatically adjust the price of all existing contracts to maintain the option market.
For those who want an estimate of what their current NUGT option will be worth, the calculation is simple. Each NUGT option contract is (usually) in control of 100 shares of NUGT at some predetermined strike price. To find the new share coverage of the option after the split, all you do is simply take the split ratio and multiply by the old share coverage (normally 100 shares). To find the new strike price, take the old strike price and divide by the split ratio. Let's look at an example of a call option contract for 100 shares of NUGT at a strike of $5.00. Since the split is 1 for 5 we divide $5.00 by 1/5, generating a new strike price of $25.00. The option will now cover 20 shares because we multiply 100 by 1/5. Thus, your new call option contract which still expires on the same day as originally scheduled, will be good for a purchase of 20 shares of NUGT for $500. On your brokerage account, the contract may be adjusted to read "NUGT1" or similar and still state it is worth 100 shares at the original price, but for redemption purposes, the contract would be redeemed for 20 shares at the post-split price.
In conclusion, we are seeing the gold miners struggle to find a bottom. This reverse split is a symptom of the struggles the mining stocks have faced. NUGT is down 60% in just six months, currently trading at $5.50. I personally believe this sell-off is a buying opportunity for long-term investors. NUGT is a short-term play in general given its leveraged nature, but is likely a buy at current prices, even pre-split. To bring the product to an investment price that Direxion believes is more attractive, it is conducting this reverse split. The reverse split of shares only really negatively impacts investors who own common shares at a total that is not a multiple of five, as they will be forced to sell fractional shares at a loss, or a potential gain, that could results in a taxable event. Owners of options contracts will not be affected besides being faced with owning a new contract at a different strike price for a different number of shares. The total value of the contract will, however, remain the same.
Disclosure: I am long GDX. I occasionally trade NUGT and NUGT options but never hold the security for more than a month or so.