The year 2013 has been horrendous for owners of gold, silver and related equities. In fact 2013 is the year in which the current gold bull market entered bear territory. The 2013 decline adds to the decline from the highs in the fall of 2012. In 2013, the SPDR Gold Trust (NYSEARCA:GLD) and the iShares Silver Trust (NYSEARCA:SLV), the two most popular ETFs that track spot gold and silver prices, are down 21.0% and 34.0% respectively. The gold and silver miners, as measured by the Gold Miners Index (NYSEARCA:GDX), the Junior Gold Miners Index (NYSEARCA:GDXJ) and the Global X Silver Miners (NYSEARCA:SIL) have been absolutely hammered in the same time frame, down 41.2%, 46.6% and 40.9% respectively. One of the best trading vehicles for short to medium-terms upside moves in the miners, the Direxion 3X Gold Miner Bull ETF (NYSEARCA:NUGT), has seen an incredible 87% loss in just year-to-date. As such, Direxion, a leader in providing popular leverage bull and bear funds, announced on March 1, 2013 it would execute a reverse share split of NUGT, which aims to provide a return 300% that of the gold miners index. However, the months of March to July saw NUGT lose another 60%, and NUGT now trades just over where it reverse split (1 for 5) just four months ago. Highlighting the problems the stocks in the gold mining space have had, Direxion believes that another reverse split is in order. On July 24, 2013, Direxion announced it would again conduct another reverse split on NUGT shares. The justification is the same as the last reverse split, that the post-split investment prices will be more attractive for buyers.
When The Reverse Split Will Occur And What Will Happen to Your Holdings
In this article I want to explain what happens during a reverse split and highlight the implications for the sector. I will also weigh in on what investors should do with NUGT ahead of the split. First, it is important to note that 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. The reverse split will be conducted at a ratio of 1 for 10 and will apply to shareholders of record at the close of the markets on August 19, 2013, and will begin trading at the adjusted price August 20, 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 10 reverse split, every ten pre-split shares held by a shareholder will result in the receipt of one post-split share, which will be priced ten times higher than the value of the pre-split share. The following example best illustrates what to expect:
If you hold 10,000 shares of NUGT priced at $5.00 each, then after the reverse split you will hold 1,000 shares valued at $50.00 each. As you can see, the reverse split does not change the value of a shareholder's investment, it still remains $50,000.
The Issue of Fractional Shares
A common issue with reverse splits is the potential creation of fractional shares. 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 ten. 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 tiny 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, albeit this is miniscule. Given that the gold and silver markets are trading only slightly above multi-year lows and the miners are still searching for a bottom, a loss is a strong possibility with NUGT, given the huge decline in 2013. To avoid this scenario, investors can purchase more shares to round out their NUGT holdings to a multiple of ten, or to sell an appropriate number of shares to round out the holdings.
Those Holding NUGT Options
You should be aware that holders of options contracts will be affected and they 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 rather simple.
Each NUGT option contract is (generally) in control of 100 shares of NUGT at some predetermined strike price. To find the new share coverage of the option after the split, you 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. For example, assume you own a call option contract for 100 shares of NUGT at a strike of $5.00. Since the split is 1 for 10 we divide $5.00 by 1/10, generating a new strike price of $50.00. The option will now cover 10 shares because we multiply 100 by 1/10. Thus, your new call option contract which still expires on the same day as originally scheduled, will be good for a purchase of 10 shares of NUGT for $500.
On your brokerage account, the contract may be adjusted to read "NUGT1", NUGT1A" or similar and still state it is worth 100 shares at the original price, but for redemption purposes, the contract would be redeemed for 10 shares at the post-split price. One important consideration is that volume on these contracts often dries up, especially when new contracts are written at the newer strike level. Thus, wide bid/ask prices can result.
In conclusion, we are seeing the gold miners struggle to find a bottom. This second reverse split of NUGT in four months is a symptom of the struggles the mining stocks have faced. NUGT is down almost 90% on the year, currently trading at $7.00. I personally believe this sell-off is a buying opportunity for long-term investors in the gold mining sector as a whole. NUGT is a short-term play in general given its leveraged nature, but is likely a buy at current prices, even pre-split. In fact, buying pre-split (provided you believe gold and silver are on the mend), can be advantageous because even though your investment value doesn't change, a higher price does tend to attract more volume and more money. 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. Despite the value of the contract not changing, I recommend not purchasing any options ahead of this split, given that volume generally dries up leading to wide bid/ask prices. Thus I recommend getting out of any options positions you may have now. Finally, remember that 3X leveraged funds are not to be bought and held. They are to be held for weeks to months at a time. NUGT will deliver returns once there is stabilization in the gold/silver mining markets. While I do think it can be bought ahead of the split if gold and silver are on the mend, I think it is best to wait for clear signals that gold and silver are going higher. Until this happens, investors should consider building positions in GDX, GDXJ, one of the larger gold/silver companies, or simply physical bullion.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. I own physical gold and silver. I have traded NUGT frequently in my investing career. I am also long individual gold and silver companies.