It's been a terrible year for gold and silver stock shareholders. It's been personally painful for me as well as I have substantial positions in many equities in this sector, as well as physical gold and bullion. To be blunt, the year 2013 has been just horrendous for precious metals- related equities. It's been so bad in fact that the current gold bull market entered bear territory. So far this year, 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 20.5% and 31.0% respectively. It pains me to even mention the gold and silver miners, knowing the positions I hold in them. I would be remiss as an author not to. 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, down 39.6%, 44.0% and 38.9% respectively this year. This takes me to my absolute favorite trading vehicle for short to medium-terms upside moves in the miners, the Direxion 3X Gold Miner Bull ETF (NYSEARCA:NUGT). This ETF aims to provide a return 300% that of the gold miners index. With the losses in the GDX and GDXJ, this ETF has seen an incredible 82% loss year-to-date. As such, 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. Talk about deja-vu. The justification is the same as the last reverse split, that the post-split investment prices will be more attractive for buyers. In this article I will briefly touch upon what will happen to current shareholders, but then focus the discussion as to whether you should consider buying the ETF ahead of the split, which I have not made clear recommendations on in the past.
Briefly, What Will Happen to Your Holdings
First, this 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. So, what does this mean? Let's say right now you own 2,000 shares of NUGT priced at $7.00 each. Given the split is 1 for 10, after the reverse split you will hold 200 shares valued at $70.00 each. As you can see, the reverse split does not change the value of a shareholder's investment, it still remains $14,000.
The Annoyance 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.
I Recommend Selling Your 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. Each NUGT option contract is (generally) in control of 100 shares of NUGT at some predetermined strike price. To find out what the new strike price will be, 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.
Here's the problem. You must understand that once a reverse split like this occurs, volume on these older contracts often dries up, especially when new contracts are written at the newer strike level. Thus, wide bid/ask prices can result. The resulting wide bid/ask price and the lack of volume makes it tough to enjoy a profitable trade. You really need to the stock to move significantly in the direction of your option (for calls that's up, and for puts that's down) in order to hope to sell the option for a decent profit. Rather than deal with this issue, it is best to sell ahead of the split, if you can afford to, to ensure there is still as reasonable bid/ask price. You can always repurchase a newer option once they are written a few weeks after the reverse split.
A Few Reasons You Can Buy Into The Split
For 2013 we have been 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 88% 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. The price action in gold miners has been positive as of late. Gold has steadily held above $1300, while silver is up nearly 20% from its bottom, trading around $21.60. While the miners have faced massive write downs, management shakeups, dividend cuts, slashing of explorations budgets and putting projects on hold, with the precious metal prices finally coming to a stable level, I think these miners are good buys at these levels. Buying into NUGT pre-split could be advantageous here, to play a leveraged rebound in miner prices. Furthermore, after these splits, provided the underlying index is moving in a positive direction, new investment dollars are often put to work in these names. I've seen many solid bumps in post-split prices as a result of this. However, I still caution that this is not a long-term investment given its daily restructuring/re-weighting of holdings. It is a short to medium term investment. I generally hold this ETF for a few weeks to a few months at most to catch nice moves in the miners and sell once I hit a double digit percentage gain. That is the recommendation that I also make for others who decide to purchase any leveraged ETF.
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 ten, 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. I think that stabilization has begun, and investors willing to take on a little risk could make a purchase for a trade into NUGT at these levels.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in NUGT over 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 Bullion