Slope of Hope Blog Posts

Slope initially began as a blog, so this is where most of the website’s content resides. Here we have tens of thousands of posts dating back over a decade. These are listed in reverse chronological order. Click on any category icon below to see posts tagged with that particular subject, or click on a word in the category cloud on the right side of the screen for more specific choices.

Revisiting a Losing Market-Neutral Trade

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In a post here in December ("Market Neutral Investing in China's Fast Food Industry"), I mentioned a market neutral trade I had entered going long Yum! Brands, Inc. (YUM), the largest fast food operator in China, and shorting Country Style Cooking Restaurant Chain, Ltd. (CCSC), a start-up fast food chain in China. I figured the bigger potential there was on the short side.

Reasons I shorted CCSC as part of this trade

  • + Its chart looked weak, with the stock trending down since its IPO last fall
  • + Its valuation looked pricey relative to its earnings, even after adjusting for growth estimates.
  • + Anticipated selling pressure when the 6 month IPO lockup period expired for insiders.

Getting Stopped out for a Loss

I used double digit trailing stops on this trade, and got stopped out of CCSC at $25.38, for a loss of 11.3% on the short side on Jan 4, so I sold out of YUM as well, at $48.21, for a loss of 4.8% on the long side. Total loss of 8% on this market neutral trade. Below is a chart of both stocks from when I entered the trade, on December 2nd, 2010, until when I exited, on January 4th, 2011. 

 

 

Hindsight is 20/20

Had I used wider stops, I might have stayed in the trade long enough to profit from it. Below is a chart of both stocks from when I entered the trade, on December 2nd, 2010, until Monday, May 9th, 2011. Note the selloff at the beginning of March: the company released earnings on March 2nd, missing analysts' estimates.

 

This wouldn't have applied in the case of CCSC, since it doesn't have options traded on it, but a suggestion that has come up recently from a couple of Portfolio Armor users is extending its algorithm to find optimal calls for hedging short positions.

Recall that with Portfolio Armor (available as a web app, and an iOS app) you just enter the symbol of the stock or ETF you’re looking to hedge, the number of shares you own, and the maximum decline you’re willing to risk, (your threshold). Then the app uses an algorithm developed by a finance Ph.D. candidate to sort through and analyze all of the available puts for your position, scanning for the optimal ones to get you the level of protection you want at the lowest cost.

Adding the ability to hedge short positions with optimal calls is something I'm considering adding, if enough users request it. If we do add that functionality, we'll probably raise the price, to offset the development cost, but those who subscribed to the web app beforehand would be grandfathered in at the current cost. I don't know if we'd add the functionality to the iOS app too, but there again, if we do, current users would get the upgrade without paying more.

Long IFSIA, Short USG

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Below is a market neutral trade I opened Tuesday morning, but first I wanted to thank those of you who have downloaded and rated the Portfolio Armor iOS app. When I checked AppShopper.com at the end of last week, I saw the screen cap below, which showed that, among the top 200 paid finance iOS apps, Portfolio Armor had the highest customer rating. Thanks again for that.

Also, quick follow up on my last post ("Speculative Options Buy Update"): In that post, I mentioned that COHR would be releasing its Q after the close Tuesday. It reported EPS and revenues that beat estimates( EPS of $0.83 vs. estimate of $0.78; revenues of $200.9M vs. estimate of $192.68M), so we got a little lucky there. The underlying is up about 3% afterhours as I type this, reversing today's decline, but we'll see how this pans out going forward. On to Tuesday's market neutral pair. 

On Tuesday morning, I shorted USG at $15.09 and bought an equivalent dollar amount of IFSIA at $18.55. I e-mailed the trade idea to those on the market neutral trade notification list before market hours Tuesday.

USG Corporation (NYSE: USG) manufactures Sheetrock and other times of wallboard. I shorted this one last year, and got stopped out for a single-digit loss. I plan on using a double-digit trailing stop this time, on both the long and short side of this trade. I’ll probably use slightly tighter stops initially this time than I did initially on the last market neutral trade (long IMO, short TRGL) though. Charts below courtesy of Finviz.com.

Short Screen shows an Altman Z-Score of 0.59 for USG. Scores below 1.81 are considered an indication of financial distress, according to the model.

USG is currently rated as having Average Accounting & Governance Risk (AGR®), receiving an AGR Score of 70 percentile among the approximately 8,000 companies in North America rated by Audit Integrity, indicating higher accounting and governance risk than 30% of the other companies.

USG had negative earnings over the trailing twelve months and has an PEG ratio of -0.19 (based on analysts’ estimates of its earnings over the next five years).

Interface, Inc. (NASDAQ: IFSIA) manufactures modular and broadloom carpets, and other floor covering products.

IFSIA has an Altman Z-Score of 3.37. Scores above 3 are considered indications of financial strength.

IFSIA is currently rated as having Conservative Accounting & Governance Risk (AGR®), receiving an AGR Score of 98 percentile among the approximately 8,000 companies in North America rated by Audit Integrity, indicating higher accounting and governance risk than 2% of the other companies.

IFSIA looks pricey based on trailing earnings, but it has a PEG ratio of 1.44 (based on analysts’ estimates of its earnings over the next five years), which looks a little more reasonable.

Speculative Option Buy Update

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Last week, I mentioned that with volatility near two year lows, I'd been spending some time looking for speculative option buys. I noted that I'd been looking to place bullish and bearish bets, so I’d have a better shot at making some money whatever direction the market takes in the next several months.

As I mentioned last week, while doing this, I’ve been keeping in mind a few points Tim made in his book, “Chart Your Way to Profits.” On p.474, Tim offered a few common sense guidelines about speculative options buying:

  • Start small (since options often expire worthless).
  • Avoid out-of-the-money-options (instead, try to get ones with some intrinsic value)
  • Avoid nearby expiration dates (to avoid theta burn and give your position more time to work out)

I noted also that in addition to Tim's three guidelines, I'd added a fourth:

  • buy options at a discount to model estimates of their fair market value.

A quick recap on my M.O. with this: for the bearish bets, I’ve been starting by scanning for relatively lightly-traded (average daily volume over the last month of 150k-200k shares or less), optionable stocks that look weak technically and fundamentally. The idea behind looking for relatively thinly-traded stocks is that the options traded on them are more likely to be thinly-traded, which increases the chances that they might be inefficiently priced. Then I look for in-the-money puts on them several months out, and compare the current bid-ask prices for them with the estimated fair market value of them via the Black-Scholes model.

If I find one where the most recent bid is significantly below the Black-Scholes fair market value estimate, I’ll place a small limit order for it, with the limit price set at a discount to the fair market value estimate.

For the bullish bets, I’ve been doing the reverse: scanning for stocks that look strong technically and fundamentally, and looking for in-the-money calls priced below the Black-Scholes estimates of their fair market value.

I mentioned Thursday that I had placed limit orders for in-the-money calls on these five stocks: AEG, SVN, SUP, ASMI, and COHR.

And limit orders for in-the-money puts on these five stocks: CPIX, LOJN, HIL, PNCL, and MDS.

Unfortunately, I went 0-for-10 on those limit orders Thursday, but I repriced the options Thursday night, and put in small limit orders for options on 8 of those stocks for Friday. I didn't see the confirm until Monday, but it turns out I got a fill on my small limit order for calls on COHR. Checking the Black-Scholes value of those options now, and their bid-ask spread as of Monday, it looks like it may be possible to buy more of them Tuesday at a discount to their Black-Scholes fair market value estimate. More on that below, but first a quick reminder about the difference between speculative options buying and hedging.

Hedging versus Betting

If I were hedging, I would enter the symbol of the stock or ETF I was looking to hedge in the “symbol” field of Portfolio Armor (available on the web and as an Apple iOS app), enter the number of shares in the “shares owned” field, and then enter the maximum decline I was willing to risk in the “threshold” field. Then Portfolio Armor would use its algorithm to scan for the optimal puts to give me that level of protection at the lowest cost.

On rare occasions (I’ve seen it happen once, so far) the optimal puts Portfolio Armor presents might be in-the-money; in most cases though, they will be out-of-the-money. Since I’m making a directional bet in the case below, though, and not hedging, I placed a limit order on slightly in-the-money options. This makes sense for directional bets (when you are willing to pay more to reduce the odds against your bet) but would be sub-optimal in most cases for hedging (when you want to get a certain level of protection at the lowest possible cost).

A Bullish Bet

Cohere, Inc. (NASDAQ: COHR), headquartered in Silicon Valley, manufactures lasers and precision optics.

Short Screen shows an Altman Z-Score of 6.48 for COHR (scores above 3 indicate financial strength according to the model).

Audit Integrity rates COHR as having “conservative” Accounting & Governance Risk (AGR®), placing it in the 92nd percentile (i.e., it has higher accounting & governance risk than 8% of the 8,000 companies Audit Integrity rates). 

COHR closed at $61.96. The bid-ask spread on the November, $60 strike calls on COHR was $6.90-$8.00 as of Monday. The Black-Scholes  estimate of the fair market value of those calls as of Monday's close was $8.78.

One caution: COHR's earnings call is scheduled for Tuesday after the close.

Market Neutral : Short TRGL, Long IMO

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Hey fellow Slopers,

Below is a market neutral trade I e-mailed to members of the market neutral trade notification list Wednesday night. I plan to place this trade Thursday. First, a quick, final reminder about the Short Screen message boards contest: today is the last day to enter to win an iPad 2 for posting a comment about a stock. Details here. On to today's market neutral set-up.

Toreador Resources Corp. (TRGL) is an oil & gas E&P based in France. I shorted TRGL as part of a market neutral trade (paired with a different long position) last July, when it was trading below $6 per share. I got stopped out for a loss a week later, when the stock was just above $7. As you can see from the chart below, TRGL went on quite a run from there, though it has since pulled back from its high earlier this year.

As of its closing price Wednesday, TRGL was trading at 12.29x its trailing twelve month sales.

Short Screen shows an Altman Z"-Score of 1.03 for TRGL (recall that Z"-Scores below 1.1 indicate financial distress, according to the model).

Audit Integrity rates TRGL as having "aggressive" Accounting & Governance Risk (AGR®), placing it in the 15th percentile (i.e., it has higher accounting & governance risk than 85% of the 8,000 companies Audit Integrity rates).

I plan on using a trailing stop here, in the event TRGL shares again buck the company's seemingly weak fundamentals and go on another run.

Imperial Oil, Ltd (IMO), an Exxon Mobil subsidiary in Canada, isn't a pure-play E&P: like its parent company, in addition to its exploration & production ("upstream") operations, it has downstream and chemical operations as well. Still, as with its parent, the bulk of IMO's earnings come from its upstream operations: 71% of IMO's earnings came from upstream operations in 2010.

As of its closing price Wednesday, IMO was trading at 1.8x its trailing twelve month sales.

Short Screen shows an Altman Z-Score of 5.24 for IMO (recall that Z-Scores of 3 and above indicate financial strength). A quick note about why Short Screen shows a Z-Score for IMO, and not a Z"-Score, as it does for TRGL: Short Screen uses Standard Industrial Classification (SIC) codes to class to categorize a company as manufacturing or non-manufacturing. Companies in SIC codes 2000-3990 are considered manufacturing companies. Although only a minority of IMO's earnings come from its refining business (part of its "downstream" operations), the company's SIC code is 2911 (Petroleum Refining).

Audit Integrity rates IMO as having "average" Accounting & Governance Risk (AGR®), placing it in the 40th percentile (i.e., it has higher accounting & governance risk than 60% of the 8,000 companies Audit Integrity rates).

I plan on using a trailing stop on IMO as well.

One Nuclear Bomb Can Ruin Your Whole Day

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Well, today would have been a pretty good day for me, were it not for one (out of about seventy…) positions. Its name is GSIC, and if it were a person, I'd be strangling it right now.

The company was taken over by eBay, bless their hearts, at a 50% premium. This means that I didn't even have a chance; I was forced out of the position at a nasty loss. This is a bear's worst nightmare.

0328-gsic

There are a couple of bits of good news is this disgusting scenario: 

(1) As always, I spread my positions very thin on individual securities. It represented about half of a single percentage point of my portfolio. So a 50% loss sucks, no doubt about it, but watering it down by that much takes a lot of the pain away.

(2) I ask myself, was it bad analysis or bad luck? I can honestly say it was bad luck. There's nothing in the chart that should have warned me about this, and I simply got unlucky. The way to manage luck, in my opinion, is to spread risk (see point (1)).

Anyway, I was delighted that the market's strength fade away today, but GSIC took that delicious piece of cheesecake served to me today and dropped a stinking dog turd on top of it.