rd80 (99.11)

Fannie Mae Play Update

September 23, 2008 – Comments (2) | RELATED TICKERS: FNMA

A while back, fellow Fool mysoftballcoach asked how those of us speculating with FNM or FRE after the gov’t intervention were doing.  I responded promising an update on my FNM gamble as it developed and here it is.

Before summarizing how the trade is going, I want to run down a few of the things I’ve done right and wrong with this play.

1.  (right) Before making the buy, I made an attempt to value the company and felt there was a reasonable chance of residual value.  My 8 Sep blog entry summarized the squishy valuation attempt.

2.  (right) Before buying in, I realized this was very high risk and it was very possible I could lose the entire bet.

3.  (right) Recognized that panic can create opportunity.

4.  (wrong) I failed to consider fund selling as the stock was kicked out of the S&P 500 and funds with share price or dividend requirements for their stocks had to sell.  This ended up not hurting me too badly, but waiting a few days would have resulted in a lower entry price.

5.  (wrong) I didn’t give enough thought to an exit strategy before buying.  I was vaguely looking for a double to sell half and let the rest run but ended up scaling that back to reduce the risk.  Again, I was lucky and this didn’t end up hurting me.  In fact, another day like today and I’d have been better off sticking with the ‘wait for a double’ approach.

6.  (right) No coulda, woulda, shoulda’s.  You can only work with where you are.  At one point last week, I considered doubling down when FNM dropped below 40 cents.  That would have been brilliant.  I chickened out with my finger on the ‘enter order’ button.  Such is life, no way to go back.

Without going in to too much detail, this has worked out ok.  I bought at about 86 cents a share after commissions.  I took advantage of the price run up this morning to sell most of the shares, recoup the buy funds and still keep a handful of lottery tickets.  By selling, the position went from very high risk/high reward to no risk with some upside potential from the remaining shares.  The few dollars profit plus the remaining shares at today’s closing price work out to about a 25% gain in two weeks and the worst I can do on the trade now is break even even if it goes to zero.

I’m not trying to talk anyone into or out of making speculative trades like this.  I strongly recommend that if you’re considering something like this you think carefully about risks involved, make an effort to come up with some valuation and a reason why the market is selling below that value, take a second or third look for risks you may have overlooked and work up a reasonable exit approach, including possible events that would change your valuation opinion. 

Thanks to angusthermopylae, mysoftballcoach and leohaas who responded to my original post and helped emphasize the risk involved in a play like this.