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Trade Alert – Bankruptcy speculative flip

Cody Willard

Cody Willard

— 2 min read

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I’m buying a tiny speculative trading position in ECTY at about 12-13 cents a share, which filed for bankruptcy yesterday. Subscriber Jahmon flagged this bankruptcy trade for us in the daily Subscriber Chat Room this morning. I told him I’d take a look and I did and I like what I see.

Remember the logic on these BK trades, as taught to me by my old mentor, James Altucher:

Buying Bankrupt companies

The day a company declares bankruptcy is often a great buying opportunity. Generally, all the selling is over. When the trading halt is lifted, everyone tries to cover their shorts forcing the stock up. These stocks can be rocket ships, doubling or tripling in the next several days.

And some more background on the trade’s concept:

James: Typically, when a company declares bankruptcy, the stock is halted by the exchanges so the company has time to disseminate the news of their downfall. Note that it’s NEVER a surprise when a company declares bankruptcy. It’s not like Worldcom was a $50 stock and then they whipped out a Chapter 11 filing while everyone was asleep. By that point Worldcom was the subject of dozens of lawsuits, headlines every day about corruption, all executives being fired, and the debt was trading for pennies on the dollar. The stock itself was around 10 cents on bankruptcy day.
Everyone who was going to bet on this bankruptcy was already short the stock. Not only were they short, but probably almost every executive was short the stock in order to hedge their worthless shares. And everyone who was long the stock as an investment had already most likely sold the stock by this point. Certainly all mutual funds were out of it by this time (they never hold a 10 cent stock).
So what happens, when a stock declares bankruptcy, it’s halted, and then the halt is lifted later that day. Well, nobody is selling (because they all already sold) and everyone is covering their shorts (the worst has already happened and it’s not going to get any worse). So these stocks tend to double or triple in value within 2-3 days, as happened in the case of Worldcom, Enron, FAO Schwartz, and countless other mega-cap bankruptcies.

Do not put much money in this trade. It’s very high risk and short-term oriented and the Bankruptcy Trades don’t always work out.

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