Ready For The Re-Bal???
June 24, 2020
PG&E Exits BK…
July 2, 2020

Event-Driven Winning…

On Monday morning, I posted an article about the extreme mispricing of Nikola Motor’s warrants (NKLAW – USA). While there were ways to arb this trade in an almost risk-free manner, I went into them naked as the spread was so damn wide. Since that time, the warrants have risen by roughly 50% (hitting a high of $41 vs roughly $28 when I posted). As the week drew on and the number of COVID cases went parabolic, I started to trim my event-driven book a bit (call it residual PTSD from the last COVID collapse). In any case, on Friday morning, with the market starting to wobble a bit, I booked the last of my NKLAW for a surprisingly good gain in the five trading days since I posted.

Admittedly, All 3 Are Full Of Shit…

When the spread had narrowed materially, I asked myself if I wanted to stick around and see if I could squeeze more juice from this lemon. “Are you kidding?” I’m up huge in a week!! Besides, NKLAW is about to suffer through an air raid of institutional selling. Time to ring the register.

The point of an Event-Driven (ED) book is to generate consistent, low-risk gains that occur over a short duration—allowing you to rapidly recycle your book. I rarely speak about this book as the situations tend to be less liquid, but NKLAW was trading tens of millions of dollars a day—how could I not write about that one?

My experience over two decades is that during periods of low volatility, my long book does very well and the ED book sort of muddles along as spreads are narrower and opportunities rapidly reprice. Then, during periods of market volatility, the wise guys who normally step in with liquidity are nowhere to be found—they probably blew up their ED books as they added leverage to compensate for sub-optimal return potential in prior opportunities. Therefore, when the market is volatile and my long book is “soft,” the ED book picks up the slack. More importantly, it generates the cash flow that lets me average down on my favorite names. The two books seem to balance each other out with near perfect chemistry.

Speaking of a “soft” long book, I don’t think most investors realize just how weak the market has been for the sorts of small-cap names I traffic in (I know, because I own a few of these companies that only seem to decline in price). Investors like to look at the Russell 2000 (IWM – USA) as a benchmark for small-cap companies. Year-to-date, the IWM is down 17%, which sounds material. However, as I was looking at the re-balancing, I saw something odd—the largest components in the index are all up quite a lot this year. Just scrolling the top 10 components before the re-balancing;

Ticker       % Change    

TDOC          +131%

CHGG          +73%

QDEL           +61%

TREX            +41%

IMMU           +67%

GNRC            +17%

FIVN              +64%

AMED            +23%

RGEN             +26%

AAXN             +31%

In total, these top 10 are a 4.25% weighting in the index and up an average of 53% this year. Imagine what the other 1990 names representing 95.75% of the index have done if the index as a whole is down 17%? I have more important things to do on a Sunday, but I suspect that the top 200 or so names are up quite a lot and the other 1800 are down by half (or that’s how I feel as an investor in smaller-cap companies).

I don’t know when, but we will eventually enter a golden age for small-cap equities as the current valuations are simply too extreme to persist forever in a ZIRP world. When it turns, I think it will be violent. Until then, Event-Driven opportunities and Premium Selling are becoming mainstays of my strategy. Remember, investing is about going where the opportunities are.

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