Risk Management | Portfolio Yoga

Tesla, The great Short Squeeze & the Lesson it Offers

You would have to be living under a rock to not have but noticed the twitter chatter around the ever rising price of Tesla’s stock. We are just one month into 2020 and yet it seems that traders who shorted Tesla may have already lost $8.3 billion this year alone.

But first, the Tesla Chart

This is a kind of move that can make or break careers. In 2009, when Porsche squeezed the shorts in Volkswagen, it ruined many fund houses then.

Hedge funds lose $30 billion on VW infinity squeeze

While one can lose money by going long in a stock, a stock can at worst go down to zero. But when you short, there is no limit on how much you can lose since there is no limit on how high the stock price can go.

Most Long – Short funds which have a large portfolio of short positions short stocks that they strongly believe are candidates for bankruptcy or are frauds. In the case of Tesla, many of the ardent short activists believe both to be true.

But my or your beliefs don’t make the market. The markets finally are Supreme even if they are wrong on many occasions. What is interesting about those who shorted or have a negative view on Tesla is how they seem to be blindsided that there are shades of Good, Bad and Grey in Tesla as it is with any other company.

I am neither an investor in Tesla nor own its Car nor tweet about US markets regularly. Yet, I have amusingly found out that I am blocked by dozens of folks and the only common thread between them is that they are bearish on Tesla.

Given that I have never followed or even replied to their tweets, the only way I would get blocked is if they specifically searched for me and blocked me. To me that shows a kind of hatred that has nothing to do with money.

But coming back to Tesla, it’s okay to be wrong but not okay to stay wrong is an adage everyone knows and yet Fund managers managing Billions of assets seem to believe that “apna time ayega”.

In India, Nifty today is a hated Index. The reason for the hate is that the Index is up while portfolio’s are down. Wouldn’t it be simpler and more profitable to own Nifty versus wallowing about how it’s all manipulated and stuff. How different otherwise are we then to folks who are bearish on Tesla and go about tweeting any and every conspiracy theory they can lay their hands upon.

Success in markets I have learnt comes in two ways. The first is to have a strategy that works on the long term for no strategy works all the time and will be wrong some of the time.

The second is behavior where one requirement is the ability to understand what is within our abilities and what is not. No point wishing for things which we cannot be influencing in any way.

It’s been 2 years since my portfolio saw an all time high. In my own past world, I would have already jumped through at least 2 if not more strategies to try and compensate for the chronic under performance I am observing.

But data I have tells me that this move has been well within the boundaries of what I should have expected. The risk was known and is well under control. As long as you have control of the risk and its not exceeded preset limits, there is no reason to switch to what is working today for tomorrow even that may stop working.

The reason for me to follow this strategy versus buying a Nifty ETF was to get a return which is greater than say buying and holding Nifty 50 and there is no reason for me to quit the same. This is one way to look at your portfolio when your strategy differs from the one everyone is tracking.

Kingfisher Airlines stopped operations in mid 2012. The stock continued to trade till September 2014. More recently we saw similar trading in Jet Airways long after the company had shut the door. I remember the same enthusiasm when Global Trust Bank botched up and it was to be acquired by Oriental Bank of Commerce with all equity being wiped out.

Investors continue to lap up even dead stocks in the faint hope that maybe one day it will all work out okay.

I am a strong believer in trends and regardless of how great a stock is, having learned my lessons at great cost, I would not wish to hold it once the stock starts to trade below its 200 day moving average. A 200 moving average is no different from say a 199 day moving average or a 201 day moving average. What all of them offer though is a defined exit that I can rely upon.

If you were short Tesla with a stop above the 200 day moving average, you would have been out of your short position when it traded at $300. Today its trading 3 times that number and we haven’t seemingly done yet.

Risk Management is critical for any Investor or Trader. If you don’t manage your risks properly, all it requires is for one to hurl you towards financial ruin for it’s a slippery slope with very little support on the way. The funds and individuals who are short Tesla today are those who ignored the Risks. Some may survive, but the harm it does in terms of psychology alone is Irreparable.

Don’t fall in love with the stock is an adage as old as the hills. It works well to remember every time we try to defend a stock we are holding for we are just side-car participants in the company’s boom or bust.There are no additional points for you just because you happen to love them more. Have a plan on containing the risk a stock can do to your portfolio and stick with it. It’s that simple to avoid financial ruin.

Playing the Russian Roulette by Selling Options

There is a new game in town – it’s called let’s play the Russian Roulette with a million chambers. The game itself isn’t new, it’s just that the players are. Unlike the real Russian Roulette with 6 chambers, in this game, you don’t know either the number of chambers that are empty nor the number of bullets that are packed.

So, how does one play this game?

Its actually very easy thanks to NSE who have introduced something called Weekly Options. Every Thursday, you wake up early, brush your teeth, sit in front of the terminal and wait for the markets to open.

Once markets are open, start selling shit load of out of the money options. Now, since these expire on the same day, you will not get much – may Rs.40 per lot or Rs.80 in case you are able to sell at Rs.2. Selling one or two of course will barely pay for a good cup of Coffee let alone lead you on to the road to riches.

You instead need to sell lots and lots of options. If you sell 100 lots, you make 4K – good but not really awesome. But what if you sell 1000 lots – 40 * 1000 = 40K, now we are onto something. And what if you can sell 10K lots?

Since you have started the day early, if markets trend in one direction, the options will crater like anything in a few minutes to an hour. You can then cover these options and sell new set of options that will give you a Rupee or Two at that point of time.

By the end of the day, all out of the money options go down to Zero and voila, all the money you made by selling those options are yours to keep. Thank the suckers who are on the other side of your trade, post your Marked to Market numbers on Twitter and you are in business.

Now, we are on the road to happyness. Do this every week and by end of a few years, thanks to Compounding you will soon be knocking on the doors of Forbes to ask them enter your name in the Top 100 list.

Wait, you would say – Selling Options require margin and most brokers provide anywhere between 4 – 8 times the capital as exposure. So, how does one go about selling hundreds if not thousands of contracts

Well, that small issue of margins is for ordinary mortals like us – extraordinary traders get extraordinary exposure. With brokerage business having gone to dogs, the only way for brokers who want to make something out of nothing is to hope that they can give the client the exposure he is asking for and by end of the day, make it out alive.

Now, you may wonder – why do people buy those out of the money options for a Rupee or two when they very well know that the chances of it going to zero are very high?

Options are like Insurance – you buy them in the hope that if things blow up, you get back something – if they don’t, all you lose out is the premium paid. This doesn’t mean that the buyers are really hedging their risks – most likely most of them are speculators who are willing to bet a Rupee in the hope that if the market cracks, they can make multiple times their investment.

While option buyers, especially those buying out of the money options do lose out, its once again just a probability and not a guarantee. Every once in a way, when things go wrong and they usually do, you don’t want to blow up because you were too busy picking up nickels to observe the speeding monster truck that are hurtling down the road.

How big is the Risk:

There are basically two kinds of Risk.

First is the risk that markets trend one sided through the day and you get caught. While this is a general risk, the probability that you will get caught badly is not since you have enough time to adjust your position and while you may still end the day in a loss, you know it is not a killer.

The real risk is one that comes unknown – assume a big negative news flows in at 2:30. You are neck deep with shorts most of which you think will go down to zero and the market suddenly dips 10% even before you know what is happening.

While your call shorts shall go down to zero, the same cannot be said about Puts and your or rather your broker’s nightmare has just begun.

To start with, NSE imposes circuits for options which mean that almost immediately all put options will all be locked in upper circuit way below the price where they should be traded. While they will keep opening, the fastness of the move and the depth of fall means that its unlikely you will get a seller to buy back your shorts.

The bigger issue is the size of the loss. Do remember, we aren’t leveraged small. Brokers I am told are giving 40 times exposure (Don’t ask me how, they can but they are essentially bending if not breaking a few laws). So, for every Crore of Rupee you put in as Capital, you can take Notional Exposure of 40 Crores.

Yesterday being an Expiry Thursday and let’s take real prices and based on an interview, real strikes where you would have gone short.

Bank Nifty Futures opened at 25,640 yesterday. With trend being up, you decided to sell multiple lots of 25,400 put options. Now these were trading around Four Rupees and lets assume you get the same price even though your own quantity may push down the price.

Since you are a big trader, you start off with 1000 lots which yields you a good 1.6 Lakh in Premium. Yesterday was a good day and you ended the day with the options going down to zero which meant that you made the total premium.

But what if you were holding the option at 2:30 (the real trader closed out his position at 0.05, a price he could have got only post 3 PM) and a flash news triggered a market fall of 5%. Bank Nifty is now at 24,350

A 1,280 fall is bad enough, but the problem for you is that the options you had sold for a princely sum of Rs.4 are now (theoretical since they would be frozen will zero trades taking place) costing a grand price of just Rs.1050.

Since you are having a total position of 1000 lots which equals 40000 (40 * 1000), your loss is now Rs.4.20 Crores (nice round figure, Right?) .

Hell with you would be your thought – I would have placed a stop and exited well before such a force majeure ever happened.

Unfortunately, the problem with stops is that they will not get executed at times like these when prices speed off one way. Even though it takes just a few milliseconds for the Stop Order to get converted to a Sell Order, markets would have moved way away from the execution price leaving up hanging in the air so to speak.

In 1995, the Singapore head Trader of Barings Bank was in a fix. He had lost a great deal of money and something had to be done. He didn’t want to take a huge risk to recover the money and hence he executed what he thought was the safest strategy – Straddles on the Nikkei with the hope that with Nikkei not moving much, he could eat up the premium and make good the loss.

When the Gods are Crazy, even the unthinkable things happen and it was no different for Nick Leeson. On January 17, 1995 at 05:46:53 JST, Kobe was struck with a magnitude 7 earthquake. While Nikkei drifted downwards and Nick tried his best to adjust the position with the hope that a reversal would take place when things returned back to normalcy, in hindsight that was the only time he could have exited taking a loss smaller than what he eventually did.

On 23^rd January with markets getting to know the full extent of the devastation, Nikkei plummeted 5.6% which more or less close out all options of ever being able to come back. Ironically, markets did recover that day’ losses a few days later but by that time the game was long lost. But rather than cut positions, he waited in the hope of recovery which never came. Eventually, on February 23, 1995, Barings was not able to meet its margin requirements on SIMEX. The total loss accumulated by Leeson was US$1.4 billion.

Selling out of the money options for a pittance is a stupid game and what amused me was the fact that the anchor of the TV Channel covering the event was all gaga about it. Taleb has a nice chart to depict the end result of the same – 1000 and 1 day in the Life of a Thanksgiving Turkey. DON’T BE THAT TURKEY, YOU WILL END UP IN THE OWEN.

Dipa Karmakar and the Risk Quandary

Before the start of this Rio Olympics, I am sure that less than one percent of people had even heard about the name of the Gymnast coming from a small state in North East India but by yesterday, she was a toast in the media with most of us hoping that she may defy the odds and provide us with the first medal. Finishing fourth is a proud achievement given the kind of support system she had versus the support system of other competitor’s and it’s entirely due to her hard work that she is now recognized and has made a name in the world of gymnastics.

But there is a dark side as well as Dipa was one of the only(?) gymnast in this Olympics to try out the artistic gymnastics vault called “Produnova” and is only the 5^th to complete it successfully in a international competition. But as Wikipedia says and I quote,

“Controversy was sparked after Fadwa Mahmoud’s first competitive Produnova attempt, where she nearly landed on her neck.

As long as the gymnast lands on her feet first, she will get credit for the vault, and because of the Produnova’s massive difficulty value, it is easy to get a high score even with poor execution. This has led several gymnasts in countries that lack funding for gymnastics to attempt the vault in order to increase their chances of medaling and therefore obtaining more funding. There have been calls for the Produnova vault to be banned due to the high level of risk”

Now, compare this to the risk taken by amateur traders. Given that most of them lack capital, they essentially try to for broke by risking big and hoping that it pays off. Unfortunately that is seldom the case as most traders end up broke after a few such try outs as high risk never means high reward all the time since otherwise it couldn’t be high risk in the first place.

For a few months now, I have been tracking open interest data of FII’s and Clients and for me, it holds up as to how Institutions think versus how Retail folk think. For starters, FII’s are never short put options (Net) which means that they Buy Put options as an Insurance policy (as its designed to be) against their Long positions. Retail on the other hand are happy to be short Puts almost all the time.

In fact, since 2012 from where my data starts, they are short futures as well as short call options and furthered by long puts only 20% of the time. 39% of the time, they are Long Futures, Calls and Puts and 41% of the time, they are either Long or Short Futures and Long or Short Call Options while remaining long puts.

In markets history, there have been very few instances of a Market Melt up while Meltdown is an often repeated headline that occurs in a regular fashion and when such a incidence happens, you know how retail clients will be positioned.

The basic idea of having options was to provide a way to limit losses by buying Insurance but given the leverage it provides, it has been happy hunting grounds for those looking for quick bucks since it provides the kind of leverage no other product does.

While stocks can take months or years for it to return 100% return, in an option you can witness 100% and more within a single day and sometimes within a few minutes. No wonder that it attracts clients who are more than happy to stake a bet hoping that lady luck favors them.

The fact that you are risking 100% of the capital posted since it can as well as easily (and normally) does goes to Zero is often overlooked with the premise being that you lose only what you bet and no more.

In the Race Course, in a Casino as well as in the Lottery business it’s always the bookies who end up on the winning side all (or almost all) the time. While there will always be a few winners in extreme short term, over the long term the only guys going to the Bank to deposit their winnings are those on the other side.

Both in the Casino and the Options market, it seems that both the Player and the house have equal advantage but as everyone knows, “The house always Wins” even though its edge is not too great. In the derivative markets, it’s said that 95% of all options expire worthless but that doesn’t mean that option writing is an easy way to generate profits. I should know it better since nearly a decade back; I nearly went bankrupt writing options. Victor Niederhoffer blew his fund as well as personal money selling put options. Nick Leeson blew up Barings Bank selling put options on the Nikkei among many other disasters (mostly of the unspoken kind).

I find it amusing when experts say, “Risk only money you can afford to lose” which to most I am sure seems to suggest that it’s better to invest in Gold / Real Estate where such investments do not merit such statements (though the same, heck, even bigger risks exist in those asset classes).

Everyone who has made it big has risked it all (thanks to Survivor Bias, we can safely ignore those who failed), be it in Land / Gold or going solo (Entrepreneurship). But risking it all doesn’t have to mean losing it all – there is a wide difference between those two and the key to survival (remember, Survival not Success) is to understand that difference.

Motilal Oswal has a motto that says “Bet Right, Sit Tight”. I on the other hand think, Bet Right (at least hopefully its Right), Bet Big (no point scoring a few pennies when you are right, Right?) and be ready to change your view if the market doesn’t move in the direction you assumed it would (Sitting tight is equivalent to sticking one’s head in the sand and hoping that the storm will eventually pass over).

As much as I wish Dipa Karmakar well, I do hope that the lessons future gymnasts not take from her success is to try out the most risky moves in an attempt to win honor and medals.

Share this:

How big is the Risk:

Share this:

Share this: