When I worked as a market maker on Wall Street we were always seeking an edge. As a market maker you have a built in edge, you see customer orders before anyone else. But for the ambitious on the trading desk, that one edge alone wasn’t enough.
You can have more than one edge…
To give them an extra edge traders focused on fundamental analysis, risk arbitrage (trading potential merger stocks against each other), technical analysis (one I focused on and learned on the trading desk) and convertible arbitrage (another of my specialties).
Coming from a place where I had lost money in investing (letting my first stock go to zero) I was looking for how the pros did it. My number one takeaway, the most important by far, was you needed an edge. It didn’t really matter what it was, there were a LOT of ways to make money, just choose one and execute it.
Many edges need a catalyst…
One piece of that edge, in many of the strategies used by successful investors and traders, is a catalyst. Interestingly, one catalyst can trigger a number of strategies which may have absolutely nothing to do with each other when you look at them in isolation.
Take the recent merger between Bristol Meyers (BMY) and Celgene (CELG). It’s a blockbuster merger that’s all over the news, I’m sure you’ve seen stories on it already. For one of my former colleagues, Harlan, that news would mean the opportunity to do risk arb.
Harlan was the risk arb guy on our desk, so he would dive into the math of the merger and be long / short the two stocks. That was his edge. He had probably seen hundreds of risk arb deals and new where the opportunity, and the pitfalls, were in risk arb. He didn’t really trade much of anything else.
Another trader would look at the contingent value right (CVR) that may be paid to the Celgene stock holders for the achievement of certain milestones, or approval of certain drugs CELG has in the pipeline. (Those rights will become tradeable, and that’s actually something I’ll look at later if the deal closes.)
Beaten down warrants, one warrant trading edge…
And then another trader, me, would see the deal and think if that deal is going on there may be value in the sector so why not take a look at:
- Are there any warrants in the sector,
- Is there a catalyst in that stock,
- Is there an arb play,
- Is there a warrant I would buy outright as an investment, and
- What do the technicals look like
Sensus Healthcare warrants look like a buy here…
That brought me to the warrants of Sensus Healthcare (SRTS, SRTSW). The warrants are exercisable at $6.75 and they expire June 2, 2019 according to the company’s general counsel.
To this point it appears Sensus has been relying on SkinCure Oncology to sell its main product, which treats non-melanoma skin cancer. As CEO Joseph Sardano stated in their last quarterly report, “SkinCure has proven to be reliable and lucrative for us with a program that provides turnkey solutions to physicians. This group is comprised of individuals with deep experience with sales of radiation equipment for other manufacturers.”
But, Sardano goes on to say in the call that Sensus is onboarding its own salesforce. As long as they can continue to increase sales, revenue was up 32% year-over-year, margins should increase. This is on the assumption Sensus pays a nice commission to SkinCure for their sales services.
Sensus has an improved product, the SRT-100 Plus, which was launched in the third quarter of 2018. The improved SRT adds “remote diagnostics, patient medical records integration, as well as core system enhancements.” It also has the capability to treat psoriasis, a fast growing market.
The company also has a new product, names Sculptura, awaiting FDA approval. Sardano noted in the call that the Sculptura system was extremely well received at a recent oncology conference and the company has high hopes for its success.
It appears the company is on a positive growth trajectory, both with current and future innovative products, and should turn earnings positive this year. The stock was beaten down along with the overall market the past few months, but has recovered rapidly and is back to the range it was in before the selloff.
I like the warrants here for a couple of reasons.
The warrants are thinly traded with a wide spread, so it is possible you could get the warrants at a discount to the common. I would only place limit orders due to the thin trading nature of the warrants.
The warrants are basically offered at parity with the common, even though there are several months left before the warrant expiration. This is because the warrants traded down, along with the stock, at the end of last year and have not regained their premium. (Remember, warrants generally trade behind the common.) The stock is shortable (check with your broker) so you could put on a hedged position, shorting the common against your warrants. (If you have no idea what I’m talking about, check out my warrants course here.)
I believe the warrants offer a good risk/reward profile here and could easily trade back to the $2 level as the stock recovers and possibly moves higher than its 2018 high.
Finally, I’ll be keeping an eye on this one for a potential Beach Ball trade as it gets closer to the June 2 expiration. If the stock moves up, or just stays in this range, it could become a good Beach Ball trade at that point.
While most of the posts here concern warrant arbitrage, this is another edge you can exploit. Buying beaten down warrants is much safer than buying beaten down stocks if you’re looking for a value play opportunity. And, as with Sensus, you can likely get the warrants at a very small premium to the stock price risking much less capital.
Please comment below with any questions. Does the beaten down warrant strategy fit in your portfolio?