Trading AERL Into a Rights Offering Expiration

I was asked to expound on a comment I made today on www.stocktwits.com concerning AERL. I believe being long AERL into its rights offering expiration this Friday is a low risk, high probability trade.

I am currently working on a free report that will be a given away on this site when signing up to my email list which goes in depth on my thinking on this subject, in either a warrant expiration or a rights offering. That will be available in a few days, but here is my take on AERL going into the rights offering expiration this week.

First, in general there is often a bounce in a stock following the completion of either a rights offering or a warrant expiration. This is due to the arbitrage that takes place between the rights (or warrants) and the common stock. Arbitrageurs short the common and go long the right (or warrant).

The result of the arbitrage is a distortion in the price of the underlying common. In a case like this, where the strike price of the right is close to the price of the common, it is not unusual for the price of the common to drop until it is very close to the strike price of the rights offering, in this case $3.

Second, one of the major indicators I examine when deciding whether or not to get long near the expiration of a rights offering or warrant expiration is what other stocks in the industry have been doing recently. In this case several of the stocks in the gaming sector have done very well the past few months (LVS, MGM, WYNN all with various amounts  of exposure to Macau). From my experience this alone is a fairly good indicator that the stock will move up in the short term following the end of the rights offering.

Third, two officers of the company, the Chairman, Lam Man Pou and the COO, Vong Hon Kun, have agreed to enter into standby purchase agreements in which they will buy shares at a price of $4.50 and will not sell, transfer, etc. those shares for two years. While the structure of this standby purchase agreement is somewhat convoluted in the SEC filings, I like the fact that management interest is aligned with the interest of the stock going up.

Having stated those points let me be perfectly clear what I’m looking for in AERL over the next two weeks. I will get long the stock as it (hopefully) declines toward $3. In this case I would be somewhat surprised if it drops much below $3.25 or so.

I’ll be using both time and price to guide my purchases. The ideal situation is that it trades at $3.01 on Friday, June 21, the date of the offering expiration. At which point I would put on a decent sized position. But, as I assume it will not quite get down to $3, I’ll be purchasing shares in the $3.25 – $3.50 range.

I expect that AERL will pop next week into the $4-$4.50 range at which point I will sell my shares. The “play” in AERL for me is a trade based on the stock moving down into the rights offering expiration and then bouncing once the offering is completed. I would be very satisfied with a 15% or so return over a few days.

Best of luck in all of your trading!