TRQ and the Third Trade of a Rights Offering

I’ve discussed two different trades that can be done in a rights offering or warrant expiration. The first and second trades, that I talk about in my eBook as well as in this post, are to be short going into an expiration and then long at the time of the expiration. But there is another trade that I haven’t really discussed before.

TRQ gives me an opportunity to talk about that third trade.

The classic pattern in a rights offering is for the stock to drop on the announcement of the offering, continue a downward slope as the offering approaches expiration, and then bounce as the distortion from arbitrage is removed upon the completion of the offering. But there is another specific period that can be traded in connection with the offering…the time period when the common stock from the offering actually lands in investor accounts.

While large investors generally don’t sell positions they have taken in an offering, specifically here that would be Rio Tinto and Friedland, many smaller investors do take a quick profit if it’s available. The result is pressure on the common stock as those investors take at least a portion of their money off the table.

So, given expected selling pressure on the stock, the trade is to be short the common the week following the offering as the new shares hit investor accounts. There are a few drawbacks to the trade, mainly in that the exact date the shares are going to be available to trade is not known. Also, I would not do this trade in a stock that was trending up prior to the offering. As the chart clearly shows, that’s definitely not TRQ.

With TRQ the offering is scheduled to close on January 13th and the shares are to be distributed as soon as possible after that date.

As I said in my earlier post, I traded the downside of this one prior to the expiration for a small profit, and then completely missed the bounce that took place after the expiration…UGH! If you did play this one using the methods I’ve described you could have brought in a 13% profit in two days…again, UGH on my part, but the risk profile of the trade didn’t fit my risk tolerance.

Having said that, I did have a hedged position which I noted in my previous post, long puts and long stock. As the stock bounced I sold part of my long position into the bounce, and now am overly short by way of being long more puts than I am long stock (this is a VERY small position, but I did want to follow the trade through for those of you who’ve asked about it).  If the “third trade” holds I expect TRQ to sell off into next week as the new shares begin trading.