The company previously announced its annual meeting would be held this Friday. Whether it’s related to that or not, volume in the company’s shares was about 40x higher than normal today. As I mentioned in this post in October, I had added a few shares at $0.75. That was the first time I had added shares since the company was trading in the .40s last year. I haven’t bought our sold any shares since October.

Shareholder Questions for AYSI Management, 4 November 2011

1) At the beginning of the year, the company announced the hiring of a new CEO, and the addition of new board members, including a new chairman. That chairman, CEO, and an additional director have since departed. Can you offer any elaboration on why they departed, particularly after so little time? Is the company looking for new CEO, chairman or director candidates currently, or is it content with the current management/board structure?

2) In responses to shareholder questions in August of last year, the company said,

We are dealing with new technology that has required numerous adjustments to our manufacturing process (to improve efficiencies and quality) which has led to downtime, limiting our capacity.

Was this new technology related to the company’s thicker Super Arcoplate? Has the number of adjustments required diminished, or is this still limiting your capacity?

3) Can you offer any clarification or update on the company’s previously announced plans to expand its manufacturing capacity? Initially, the company discussed building additional mills in Western Australia, beyond the current two; later, the company announced it was purchasing a much larger property in Indonesia. The company announced at the beginning of this year that the Indonesian purchase had been completed. Has the company started building new manufacturing capacity there? If not, why?

4) The fixed asset balance continues to grow. Is this related to developments in Indonesia?

5) Operating expenses were significantly higher in this third quarter than previously, approximately 3 times as high as last year and $300,000 higher than last quarter. It’s mentioned in the release that it’s “due to increasing administration resources and associated costs”. Does the company anticipate operating at these elevated levels going forward? Are these expenses related to Indonesia at all (or just Australia)? Any one-time items related to the departed executives?

6) Inventory balances continue to grow. Are these finished goods inventories? Are they related to specific orders that will be shipped?

7) Has the company explored a sale? Bradken has shown it is willing to consolidate smaller players in the industry and is willing to pay a healthy multiple to do so. At 2.5x sales, or approximately what Bradken paid in its last 2 acquisitions, the company is valued at $60.0 million, or 4x the company’s current valuation.

In the article announcing he was awarded Entrepreneur of the Year by Ernst & Young, Gene Kostecki said he wanted to list the company on the Australian Stock Exchange at some point. Does the company have a time frame in mind for this? Would it also keep a US listing of some kind (whether on the Pink Sheets, or elsewhere)?

9) Is the company concerned about the political situation in Australia (such as calls for a carbon tax)?

10) Is the company concerned about the possibility of a “hard landing” in China in the near term leading to a drop-off in demand for iron ore? Is the company hedging against this possibility in some way?

Related posts:

1. Alloy Steel Update Seeking Alpha published this article of mine yesterday which recaps...
2. Updates for 6.09.2011 Portfolio Armor update The finance academic who developed Portfolio Armor’s...

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Dozer Bucket Fitted with Polished Arcoplate from Alloy Steel International

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The finance academic who developed Portfolio Armor’s algorithm successfully defended his doctoral thesis and now has his Ph.D. He and I plan to meet later this month to discuss adding the capability to Portfolio Armor to hedge short positions with calls (should be doable) and potentially adding collar capability (will require some preliminary research to determine feasibility). If we end up adding these new capabilities, I’ll have to raise prices for new subscribers to offset the development costs, but I will grandfather current subscribers at current prices.

Meet the winner of the Short Screen message boards contest

Adam Sharp, of Bearish News:

Back in April I entered a contest at ShortScreen.com. Ended up winning an iPad2!

So thanks to Dave Pinsen and the guys over there. My blogging productivity is at near-year lows, thanks to the new precious. And my 24 mo kid monopolizes it if I take it out around him. Two, and he plays Angry Birds. By himself. I’m glad I won this thing, because I probably wouldn’t have swallowed my anti-Apple pride and bought one.

News from Alloy Steel

The stock dropped 18% Wednesday on this news from the company:

Following a review of the company organization structure CEO John Cleland has departed the Company effective 27 May 2011. The Company will advise shareholders of the revised organization structure in due course.

If I didn’t own any of the stock, I’d probably buy here, but I already own plenty of AYSI, and I decided after last summer’s excitement that I wouldn’t buy any shares of it over a buck again.

In other AYSI news this week, Alloy Steel’s founder Gene Kostecki was nominated as a candidate for entrepreneur of the year for Western Australia by Ernst & Young. The E&Y profile of Kostecki included this bit about his future plans for the company:

Gene’s financial goal is to increase sales to $300 million by 2015. Having recently come off NASDAQ, he is looking to list on ASX. To this end, the company has appointed an independent chairman and board and is in the process of establishing a new corporate governance system consistent with ASX principles.

The company has just completed an Indonesian land purchase in a manufacturing estate, funded out of cash flow. Gene intends to build a factory to allow ASI to achieve its growth aspirations, which will be funded by a mix of debt and equity. He plans build up a substantial manufacturing hub in Indonesia, while maintaining his Australian operations, and using Australia as a research and development base.

Two recent Seeking Alpha articles by me

– Groupon, Grilled Cheese, and Internet Bubble 2.0

– Germany continues to outpace the U.S. in job creation

Two exits of speculative options bets this week

As I posted on Short Screen at the time, I got out of AIB puts for a 25% gain, and out of NAK puts for a 40% gain.

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TRGL versus IMO

The chart below shows the performance of TRGL and IMO from when I entered the trade on 3/31/2011 until when I exited on 4/21/2011. I started out with 24% trailing stops on both sides of this trade, but as I noted on Short Screen at the time, I tightened those trailing stops on both sides (to 8%) on 4/19. So I got stopped out of TRGL early on 4/21 — at $7.58, instead of $8.85, which is where it closed that day. Once I got stopped out of TRGL, I sold my long position in IMO. Overall, it wasn’t a bad trade: I made 3% on the long side and 30% on the short side, for a combined return of 16.5% on the combined trade.

Why TRGL popped on 4/21

The company, an oil & gas E&P with its operations in the Paris Basin, had been under a cloud as the French government considered banning shale exploration for environmental reasons. On 4/21, the company commented on an interim report about shale exploration by a French government agency, but there was nothing conclusive about that report; the pop on 4/21 looks like it was a simply a short squeeze.

Performance of TRGL from 4/21 until this week

The chart below shows how TRGL shares have done since I got stopped out on 4/21.

Why this was a missed opportunity

Because the bearish case against TRGL hadn’t materially changed on 4/21, so I should have taken advantage of the bounce and bought in-the-money puts on it then. I didn’t think of that at the time.

Buying puts on a stock after getting stopped out of a short position

The odd thing is that I did do that when I got stopped out of the short side of another market neutral trade (Short JOE, Long GTY) for a loss earlier this year. Since I thought the bearish case against JOE remained intact, I bought long-dated, in-the-money puts on it (which I’m still holding). It’s something I’ll consider going forward when I get stopped out for gains as well.

A reminder about hedging versus betting

Those puts on JOE were a speculative bet against  the stock; because of that, I bought in the money puts on it, consistent with Tim’s guidelines about buying options in Chart Your Way to Profits. That makes sense for directional bets (when you are willing to pay more to reduce the odds against your bet) but would be sub-optimal in most cases for hedging (when you want to get a certain level of protection at the lowest possible cost).

If I were hedging, I would enter the symbol of the stock or ETF I was looking to hedge in the “symbol” field of Portfolio Armor (available as a web app and as an Apple iOS app), enter the number of shares in the “shares owned” field, and then enter the maximum decline I was willing to risk in the “threshold” field. Then Portfolio Armor would use its algorithm to scan for the optimal puts to give me that level of protection at the lowest cost.

On rare occasions (I’ve seen it happen once, so far) the optimal puts Portfolio Armor presents might be in-the-money; in most cases however they will be out-of-the-money.

My most recent market neutral trade

I entered another market neutral trade last Friday, long ALB, short ADES. More details on that at the link.

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Reasons I shorted CCSC as part of this trade

• + Its chart looked weak, with the stock trending down since its IPO last fall
• + Its valuation looked pricey relative to its earnings, even after adjusting for growth estimates.
• + Anticipated selling pressure when the 6 month IPO lockup period expired for insiders.

Getting Stopped out for a Loss

I used double digit trailing stops on this trade, and got stopped out of CCSC at $25.38, for a loss of 11.3% on the short side on Jan 4, so I sold out of YUM as well, at $48.21, for a loss of 4.8% on the long side. Total loss of 8% on this market neutral trade. Below is a chart of both stocks from when I entered the trade, on December 2nd, 2010, until when I exited, on January 4th, 2011.

Hindsight is 20/20

Had I used wider stops, I might have stayed in the trade long enough to profit from it. Below is a chart of both stocks from when I entered the trade, on December 2nd, 2010, until Monday, May 9th, 2011. Note the selloff at the beginning of March: the company released earnings on March 2nd, missing analysts’ estimates.

This wouldn’t have applied in the case of CCSC, since it doesn’t have options traded on it, but a suggestion that has come up recently from a couple of Portfolio Armor users is extending its algorithm to find optimal calls for hedging short positions.

Recall that with Portfolio Armor (available as a web app, and an iOS app) you just enter the symbol of the stock or ETF you’re looking to hedge, the number of shares you own, and the maximum decline you’re willing to risk, (your threshold). Then the app uses an algorithm developed by a finance Ph.D. candidate to sort through and analyze all of the available puts for your position, scanning for the optimal ones to get you the level of protection you want at the lowest cost.

Adding the ability to hedge short positions with optimal calls is something I’m considering adding, if enough users request it. If we do add that functionality, we’ll probably raise the price, to offset the development cost, but those who subscribed to the web app beforehand would be grandfathered in at the current cost. I don’t know if we’d add the functionality to the iOS app too, but there again, if we do, current users would get the upgrade without paying more.

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• Start small (since options often expire worthless).
• Avoid out-of-the-money-options (instead, try to get ones with some intrinsic value).
• Avoid nearby expiration dates (to avoid theta burn and give positions more time to work out).
• Buy options at a discount to model estimates of their fair market value.

I’ve been making bullish and bearish bets to increase the chances that some bets will make money whatever direction the market takes over the next several months. I’ve also been trying to take advantage of relatively low volatility when buying options (though if volatility keeps ticking up, I may start to hold off on making new speculative options buys).

On Tuesday night I placed limit orders for several small bullish and bearish bets. I got a fill on a two of them during the day Wednesday, calls on IXYS and puts on OMER. More on those below. First, a recap of my modus operandi here, and a reminder about the difference between speculative options buying and hedging.

Looking for Speculative Options Bets

For the bearish bets, I’ve been starting by scanning for relatively lightly-traded (average daily volume over the last month of < 200k-225k shares), optionable stocks that look weak technically and fundamentally. The idea behind looking for relatively thinly-traded stocks is that the options traded on them are more likely to be thinly-traded, which increases the chances that they might be inefficiently priced. Then I look for in-the-money puts on them several months out, and compare the current bid-ask prices for them with the estimated fair market value of them via the Black-Scholes model.

If I find one where the most recent bid is significantly below the Black-Scholes fair market value estimate, I’ll place a small limit order for it, with the limit price set at a ~20%+ discount to the fair market value estimate.

For the bullish bets, I’ve been doing the reverse: Scanning for stocks that look strong technically and fundamentally, and looking for in-the-money calls priced below the Black-Scholes estimates of their fair market value.

Prior to today, I used this M.O. to purchase puts on JOE, NAK, MOTR, TNDM; and calls on HMC, HIT, COHR, SUP, and ASMI. I noted these purchases at the time on the Short Screen message boards.

Hedging vs. Betting

If I were hedging, I would enter the symbol of the stock or ETF I was looking to hedge in the “symbol” field of Portfolio Armor (available as a web app and as an Apple iOS app), enter the number of shares in the “shares owned” field, and then enter the maximum decline I was willing to risk in the “threshold” field. Then Portfolio Armor would use its algorithm to scan for the optimal puts to give me that level of protection at the lowest cost.

On rare occasions (I’ve seen it happen once, so far) the optimal puts Portfolio Armor presents might be in-the-money; in most cases however they will be out-of-the-money. Since I’m making a directional bet in the cases below, though, and not hedging, I bought slightly in-the-money options. This makes sense for directional bets (when you are willing to pay more to reduce the odds against your bet) but would be sub-optimal in most cases for hedging (when you want to get a certain level of protection at the lowest possible cost).

A Bullish Bet

IXYS Corporation (IXYS) is a an integrated semiconductor company.

IXYS has a PEG Ratio of 0.29, based on analysts’ estimates of its earnings over the next five years.

As of Tuesday’s close, the Black-Scholes estimate of the fair market value of IXYS’s $15 strike, October calls was $2.23. I bought them for $1.80 Wednesday (the B-S estimate of their fair market value dropped to $1.97 after Wednesday’s drop in price of the underlying).

A Bearish Bet

Omeros Corporation (OMER) is a clinical-stage biopharmaceutical company. These are the kinds of stocks I generally prefer to bet against with puts rather than by shorting them, because they can spike on news of an FDA approval, or a partnership deal with a big pharma company.

OMER has a PEG ratio of -0.4 based on analysts’ estimates of its (negative, expected) earnings over the next five years.

As  of Tuesday’s close, the Black-Scholes estimate of the fair market value of the $7.50 strike, November puts on OMER was $3.50. I bought them at $2.85 Wednesday (the B-S estimate of their fair market value rose slightly to $3.57 after the drop in the underllying Wednesday).

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– I exited the Short TRGL / Long IMO Market Neutral Trade Thursday for a 16.5% gain (30% on the short side, 3% on the long side). TRGL spiked up 22% on Thursday, but I covered early, since I had tightened my trailing stops from 25% to 8% on Tuesday.

– Alloy Steel International released its fiscal Q1 numbers early Thursday: a sequential drop to “OK” from Q4’s record numbers. The thesis still seems to be intact, so I’m holding here. Looks like Q2 will probably be unimpressive as well, though, so patience may be required with this one.

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