What do the Reverse Stock Splits in $QID and $DXD Mean?

May 24, 2018, 14:24 pm ET, BY Thomas H. Kee Jr- Editor, Stock Traders Daily| Editor: Thomas H. Kee Jr. (Follow on LinkedIn)

Reverse stock splits in two leveraged short – market ETFs open the door for efficient institutional participation on the short side of the market.

Specifically, ProShares UltraShort Dow30 (NYSEARCA: DXD) and ProShares UltraShort QQQ (NYSEARCA: QID) had 1x4 reverse stock splits today.  These ETFs are now four times the price they were yesterday and anyone who held the shares overnight only has 25% of the number of shares they had yesterday too. 

There is no change to existing shareholder value, except in one sense.  When it comes time to sell the shares there is far less pricing skew, and investors who pay commissions in pennies per share will only have to pay 25% of what they would have otherwise paid.

The pricing skew is very important.  DXD, for example, was trading at $8.23 yesterday.  That means the spread between the bid and ask, if it was only $0.01, was actually 0.12%.  This may not sound significant to the naked eye, but it can add up fast, and it deters institutional investors. 

Using DXD as an example, a $0.01 move also required a 17 point move in the Dow Jones Industrial Average (QID had a similar relationship with the NDX).  Therefore, to get around the skew (or spread risk) the DOW would need to decline by 17 points, but that’s not all.  Commissions also matter.

Institutional investors pay commissions per share.  If they didn’t they would run the risk of their brokerage firm ‘working the order’ for a better price.  That would make the pricing skew even worse.  Brokerage firms like Charles Schwab (NYSE: SCHW) and Fidelity are examples of firms we have known to ‘work the orders.’  They do this because they don’t make much money (they may even lose money) from the flat fees they charge in commissions after they pay the exchanges their per-share rate.  The NYSE and NASDAQ, for example, charge the brokers a per share rate and the brokers need to pay that somehow.  The more shares that are purchased, the higher the expense, so when investors move from the retail level to the institutional level the brokers prefer the per share commission model too.

Our research shows that firms like JP Morgan (NYSE: JPM) and Goldman Sachs (NYSE: GS) charge about $0.005 per share to buy and sell.  That means, each round trip trade costs $0.01.  Again, this does not sound like much until you factor in the required move in the DOW.  When DXD was $8.23, the required move to cover commissions was also about 17 DOW points.  That is over and above the pricing skew, and spread risk.

Therefore, the DOW needed to decline by about 34 points before an institutional investor could even begin to make money in DXD, when the price was $8.23.  After the reverse split though, that has changed.  Now, the DOW only needs to decline by about 5 points to begin to make money.  That removes a barrier to entry for institutional investors.

We also use these ETFs actively in our Strategic Plan Strategy, Sentiment Table Strategy, and Swing Trading Strategies, so we recognize the added value of these reverse slits.  I have also personally petitioned for these reverse splits, and finally they have come.  The result will significantly reduce commissions, and significantly reduce pricing skews.

Additionally, it will open the door for a greater degree of institutional participation, and that means liquidity.  We expect dollar volume levels to increase meaningfully in DXD and QID as a result.

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