Gator Capital Blog Blog of Gator Capital Management

Short-Term Opportunity in FFBC Warrants

There is a short term trading opportunity in First Financial Bancorp warrants (FFBCW). A large holder of FFBC warrants is liquidating his stake.  FFBC reported a good 3rd Quarter and the stock is rising, but the price of the warrants is flat to down as the holder sits on the offer side of the market. I estimate this large holder has sold ½ to 2/3 of his position. He could finish selling his position Monday or Tuesday. After he is “cleaned up” I would expect the price of these warrants to recover to higher implied volatilities.

The large holder of FFBC warrants could be Castle Point, which is run by Todd Combs. Combs was recently hired by Warren Buffett to run a sizeable portion of Berkshire Hathaway’s investment portfolio. Combs is liquidating Castle Point. According to Castle Point’s 13-HF filed in August, Castle Point owned 304,917 FFBC warrants. There are only a total of 465,117 FFBC warrants outstanding. Castle Point owned 65.56% of the issue!

I estimate Castle Point has sold most of its holdings of FFBC warrants. Since the announcement of Buffett’s hiring of Combs, the volume of FFBC warrants traded has risen substantially. The total FFBC warrants traded since the October 22nd announcement is 220,697. Assuming that a very high percentage of these were sold by Castle Point, the firm could be as much as 50% or 2/3 done selling its position.

I expect the warrant’s price to return to higher implied volatility once Castle Point has completed its selling. Below is a table showing FFBC’s stock price, warrant price and warrant implied volatility on different dates. The first date was June 2nd, which was the date when bids were due in the Treasury auction of FFBC warrants to the public. The next date is September 30th, which was the most recent quarter end and a day when some volume of FFBC warrants traded. The last day is last Friday, November 5th.

In the table, we can see the current implied volatility of the warrants is lower than it has been on the previous dates. I believe once Castle Point is doe selling its position that the implied volatility of the FFBC warrants will slowly rise back to somewhere in the low-40’s. If I am correct, a low-40’s implied volatility at the current stock price would imply that the warrants would rise between $1.00 and $1.50. This would be a 14% to 21% increase in warrant value.

My suggestion is to wait on the bid side of the market and let the large seller push the price down to your bid. If the seller does not hit your bid in the next two or three days and volume of the warrants approaches 100,000, then you may want to get more aggressive with your bid. Once the large seller is done liquidating his position, I expect the volume of FFBC warrants to decline materiallyand will be difficult to buy. It is possible that future traded volume will be higher than it was prior to the Castle Point liquidation because the outstanding warrants will be held more widely. Another consideration is hedging your warrant purchase to protect against the stock declining. FFBC has rallied since reporting a decent quarter last week. It is not clear whether the rally will continue or if the recent price move was blip. I would argue the recent rally in the stock has allowed the large seller to exit his position for a decent nominal price even though the relative value price based on implied volatility is low.

Disclaimer: This is not investment advice. Investing in warrants is risky. Please see your financial advisor for independent investment advice. I do not have first-hand knowledge that Castle Point is responsible for the recent selling of FFBC warrants. I have used the mosaic theory to make my conclusions based on Castle Point’s SEC filing, Berkshire Hathaway’s press release, articles in the Wall Street Journal, and volume data from the NASDAQ. If you first read this post after November 9, 2010, the opportunity in FFBC warrants is likely gone.

Disclosure: Long FFBCW