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I lose... CBOE changes the rules :(

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June 16, 2009 – Comments (4)

http://www.optionsclearing.com/market/infomemos/2009/jun/25986.pdf

Yikes...  If any of you follow ACAS at all you may know that since last fall they have had to declare a dividend of about $1.07/share by this June 15th.  They declared it last week, and the stock has soared.

The dividend is enormous compared to the share price, but it is being paid as 90% stock/10% cash, which is a small net loss to shareholders due to the tax burden...

But the fact that the dividend had to be paid set up a nice trade.  The trade works like this:

1.  buy a share of ACAS

2.  sell an in-the-money ocvered call (in my case November and January $2.50's) to hedge against the downside, with the stock at ~2.70 those were paying ~1.10.  So you put $1.60 into the share, you get 11 cents cash from the divi and 96 cents worth of stock.  The break even price for ACAS shares is a little over a buck and you're double your money if the stock is at $2.20 or so...

So thats a pretty decent trade in my book..

Except the short options now have to deliver the dividend along with the shares, which means, I think, that I lose.  I didn't know they could do that.  Also, I'd LOVE to hedge my ACAS shares right now because its fairly well destined to drop like a stone ex-divi when short interest returns...

Sucks. 

4 Comments – Post Your Own

#1) On June 16, 2009 at 11:24 PM, awallejr (79.68) wrote:

Yup, I think you do.  As for how the stock will react ex-div on June 18th, I don't know.  You would think it would just drop 10 cents, the cash portion since the balance in stock really won't be known until August.

I'd be surprised of any serious shorting tho since the price is so low as it is to where the risk appears more than the reward.  I am still of the view that you will see a nice rally run in all financials come July earning's season.  Dips now in financial stocks might be a nice short pop play.  But then that is just my conjecture.  I've been pushing BAC short term and BAC and C longterm (people will be underestimating C's international exposure). August calls for the short run, January 2011 long term on BAC might prove profitable.  As for C, until the conversions are completed you will see drag on the price tho.

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#2) On June 16, 2009 at 11:30 PM, checklist34 (99.71) wrote:

hey awall, nice input.

I'd love to read a blog by you on your thesis for C long term.  C ocnfounds me to some extent, but I like BAC long term.  I own some C preferreds subject to conversion.

I think the recent rally in ACAS was ignited by short covering - I wouldn't want to be s hort a stock at $2.70 if I had to pony up a $1 divi...  and I think the short interest in this market hasn't been showing a whole lot of common sense.  Short interest in BAC peaked at its march lows, same for LVS, etc.  Nobody is covering in a timely fashion... 

Anyway, i wouldn't be surprised to see a bit of a short attack ex-divi.  Once you can be short, but aren't in a position where you have to deliver the $1.07... shorting ACAS almost makes sense. 

The lower the price can be driven, the greater the dilution, meaning the less valueable what you have to pay back is.   you could in theory short 1% of the company and only wind up having to pay back 0.6% of it or something like that.

I 100% agree with you that going short ACAS is a bit like sitting down for a nice play with a bottle of gasoline and some matches...  they announce they've cured their default and you're toast if you're short.  Could happen any day, might never happen, but its a risky stock to be short.

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#3) On June 17, 2009 at 12:09 AM, awallejr (79.68) wrote:

There are many reasons for C's LONG term play.  The preferred conversions first helps save it from having to pay billions in dividends.  And eventually they will be able to buy back the Government's stakehold. Also the banks in general have been doing quite well on refinancings; they make out like bandits on the Yield spreads; they are lending out money at low to practically no cost to them; they are slowly but surely moving out the foreclosure inventory (tho we still have a long way to go), and with lower prices, still historically low interest rates and tax credit seem to be helping to improve sales and we are now in the season. C in particular has a much greater international exposure.  Even their CEO mentioned this area of growth at a recent conference played off Bloomberg the other day.

The conversions will put pressure on the shares short term, but once they are done, just start accumulating the sucker and throw it in the vault.  Even selling December 3 puts is a great play.  Yes you have to sequester the cash for the potential purchase, but you make a sweet premium whether it gets called or not.

BAC as well can pay off handsomely both short term and long term.

These banks really are over capitalized now.  And as time goes by their earnings power will only increase. However, if you are of the view that things will never get better but only worse, then best invest in gold and bullets I suppose. But I am confident you are not in that school Chck.

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#4) On June 17, 2009 at 3:35 AM, checklist34 (99.71) wrote:

you have a genuinely contrarian attitude about banks and their cap levels.  "contrarian" is the most bastardized term in the investment world today.  On march 5th I had a convo with a cousin and he said he refused to buy until stocks went lower, maybe close to 600 even on the S&P.  He said "i can be pretty contrarian sometimes" as a justification.  NOBODY was thinking a rally was about to ignite, so contrarian just then was Doug Kass posting that we were going to S&P 1050 by the end of summer. 

Saying banks are over-capitalized is contrarian, without a doubt that ist he variant viewpoint.  But I think you're right.  Godspeed.

I sat down one day and crunched a mob of numbers on C.  I don't have them here, so these are rough guesses, but...

they made 20B in good times, the share was ~50 bucks in good times.

Some of their business units are likely, or so I surmise, to be run-off.  That leaves something less than 20B profits all other things equal (as you observe above, and as Warren Buffet observed right at the bitter bottom in early March, banks may be coming into a sort of golden era for profits).

At $3.25 the mkt cpa is 18B, which clearly leaves enormous room for appreciation if they can make 15B.  except for the dilution... 

They stand to be diluted 75% or more.  Meaning that if they returned to previous valuations and if they returned to previous profitability they may wind up worth only 10-12 bucks/share.  Still a great return from here, but...  How much is being run off?

I think thats where I got confounded before.  Trying to estimate how much of C was going to get run off.  How much of their profits were falacy in the past and not likely to return.  I wound up concluding that 7 bucks was a realistic upside (I have 20 bucks realistic for BAC 30-35 in a good case) and at the time the shares were 4 bucks, so I bought the preferreds instead which were the equivalent of about 2.80/share. 

I sure hope you're right, awall. you're always a good read.  Thanks for the comments. 

I think C will see some selloff after the conversion, as you mention.

 

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