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Dirty Texas Hedge
A GENTLEMAN’S PRIMER ON SHORTING INSOLVENT SHITCOS So you’ve found a ShitCo. It’s such an ugly zombie it couldn’t be an extra in season 19 of The Walking Dead But it’s still got a $185m cap And you want to be the one to mung the last rancid, putrefying drops out of that corpse
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Dirty Texas Hedge Apr 27
Replying to @HedgeDirty
SADDLE UP, COWBOY You may be short But you’re in for a long ride
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Dirty Texas Hedge Apr 27
Replying to @HedgeDirty
Obligatory Throat Clearing: You are indeed performing a valuable service You *do* make capital market more efficient. They *do* need you to function well You are Righteous Vigilante, policing the bullshit no one else will But you need to understand the trade you’ve put on
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Dirty Texas Hedge Apr 27
Replying to @HedgeDirty
Why on earth would a company whose debt trades at 80 still have any equity cushion left? Because the equity has become an option, and options retain value until they expire, no matter how far out of the money they are
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Dirty Texas Hedge Apr 27
Replying to @HedgeDirty
An Illustrative scenario: has with 80% prob an EV of $750M, but with 20% an EV of $1.25B. E[EV] = $850. However it has $1B of debt. At expected value (and median outcome), the company is insolvent. Which is why you’re short it. The equity should be worth nothing
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Dirty Texas Hedge Apr 27
Replying to @HedgeDirty
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Dirty Texas Hedge Apr 27
Replying to @HedgeDirty
The holders of debt have a 20% of getting all their money back, and an 80% chance of getting 75c on the dollar. They will price the debt at 80c, or a bit higher depending on the coupons
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Dirty Texas Hedge Apr 27
Replying to @HedgeDirty
The holders of equity cannot go below zero, and they have a 20% chance of a result where there’s $250M of legitimate EV over the debt load. Equity should therefore be valued at $50M
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Dirty Texas Hedge Apr 27
Replying to @HedgeDirty
But that’s also not right, because options are not priced on expected value. They’re priced on volatility of the underlying and time to expiry. They’re worth quite a bit more than expected value. The equity is not a 20% 1-shot chance but a 20 delta option
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Dirty Texas Hedge Apr 27
Replying to @HedgeDirty
OK then. When’s expiry? The fuck do you mean, “expiry”? It’s an insolvent company! It should be in BK! RIGHT THE FUCK NOW Oh, no. You silly child
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Dirty Texas Hedge Apr 27
Replying to @HedgeDirty
“Expiry” for an insolvent ShitCo is when they become *illiquid*. Only banks and trade shops go BK immediately because only they become *illiquid* immediately Normal companies are not like that. Normal companies have fixed debt maturities and revolving lines of credit
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Dirty Texas Hedge Apr 27
Replying to @HedgeDirty
So you check their 80-trading notes 6 3/8 quarterly coupons. Callable. Mature 11/15/2022 Fuck.
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Dirty Texas Hedge Apr 27
Replying to @HedgeDirty
Next, the revolver 10% drawn. Secured by the assets. 25 random regional banks, led by the Big Bank that also underwrote the notes and advised the M&A deal that’s sinking them. Renewed 2/15/2018, matures 9/15/2023 Fuuuuuuuuuuck
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Dirty Texas Hedge Apr 27
Replying to @HedgeDirty
Ok, maybe they break a covenant. Back to the 6 3/8 notes Issued 11/1/2012. “Covenant-Lite” FUCKFUCKFUCKFUCKFUCK
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Dirty Texas Hedge Apr 27
Replying to @HedgeDirty
Time to expiry: 931 days Did you really think execs with a captive board and vague performance targets will file before they have to? NINE HUNDRED THIRTY ONE MOTHERFUCKING DAYS That’s a looooong time ‘til midnight. Until then, you get to be short a 20-delta, 30-vol option
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Dirty Texas Hedge Apr 27
Replying to @HedgeDirty
20-delta, 30-vol options with 931 days to expiry have meat in them. That’s why the market cap is $185m rather than $50m or $0 Ugh. OK. Wait, where’d that vol come from? Back up further. What’s the underlying? Oh, right… Duh
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Dirty Texas Hedge Apr 27
Replying to @HedgeDirty
Bubbling Crude Oil, that is Black Gold Texas Tea
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Dirty Texas Hedge Apr 27
Replying to @HedgeDirty
As of this writing, futures for West Texas Intermediate delivered to Cushing, OK during the month of December 2022 last settled $36.57/BBL. Z22 Options expire 11/14/22 The $60 strike call last settled $1.85 Implied vol: 29.8
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Dirty Texas Hedge Apr 27
Replying to @HedgeDirty
As of your reading, see for yourself:
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Dirty Texas Hedge Apr 27
Replying to @HedgeDirty
What are the greeks on being short that? Delta: -.227 Gamma: -.017 Vega: -.176 Theta: +.003 Rho: -.165 See for yourself:
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Dirty Texas Hedge Apr 27
Replying to @HedgeDirty
To summarize: You lose money if the price of oil for Dec 2022 goes up You lose money *at an increasing rate* if oil goes up You lose money if the *volatility* of Dec 2022 oil goes up You make money at the rate of 0.3 cents per barrel per day That is your position
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Dirty Texas Hedge Apr 27
Replying to @HedgeDirty
Also note that this option you are short is American. Not that it matters for theoretical call option pricing, but it *does* matter for you. Because do you know what happens if at any point in the next 931 days it goes in the money?
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Dirty Texas Hedge Apr 27
Replying to @HedgeDirty
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Dirty Texas Hedge Apr 27
Replying to @HedgeDirty
Mmhmm That revolver? Renewed. A little smaller, 5 fewer banks. But 2027 maturity Those notes? Called. The new ones floated? 7 7/8 coupon, tighter covenants. But 2029 maturity That debt is rolled, and your hide is raw
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Dirty Texas Hedge Apr 27
Replying to @HedgeDirty
You get to hold that short for five more years ONE THOUSAND EIGHT HUNDRED TWENTY SIX MOTHERFUCKING DAYS
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Dirty Texas Hedge Apr 27
Replying to @HedgeDirty
Stocks for optimists, bonds for pessimists. Value vs growth investors The options dichotomy is long gamma / short theta vs long theta / short gamma Both styles make money, but most traders can only do one effectively. You have to know your natural style
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Dirty Texas Hedge Apr 27
Replying to @HedgeDirty
Long gamma traders know in their bones tail events are not only more likely but will happen sooner. Bleeding theta doesn’t bother them because the asshole on the other side is a complacent laxbro who will get what’s coming. They have contrarian streaks and Taleb shrines
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Dirty Texas Hedge Apr 27
Replying to @HedgeDirty
Long theta traders know in their bones neurotic pussies overpay for metaphysically impossible tail risks. Short gamma doesn’t bother them because the asshole on the other side is an over-Zerohedged paranoiac. They have colossal egos and insurance execs for fathers
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Dirty Texas Hedge Apr 27
Replying to @HedgeDirty
Who are you? You are Righteous Vigilante, delivering to capital markets the justice no one else will. Vigilantes know in their bones justice must not only be merciless and dramatic enough to set an example, it must also be swift. Justice delayed is justice denied
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Dirty Texas Hedge Apr 27
Replying to @HedgeDirty
You are a long gamma trader You are in a short gamma trade And it will drive you insane Because being short gamma for two and a half years just to collect 0.3 cents per barrel per day is a shitty, shitty way to live
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Dirty Texas Hedge Apr 27
Replying to @HedgeDirty
In six months, you will go from normal, well-adjusted, shrewd investor to garden variety antisocial cynic to Rand Paul crazy to Ron Paul crazy to Zerohedge crazy to Alex Jones crazy and then into darker, really unsavory types of crazy
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