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Dirty Texas Hedge

@HedgeDirty

17 hours ago, 54 tweets, 9 min read

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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 

SADDLE UP, COWBOY
You may be short

But you’re in for a long ride 

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 

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 

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 

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 

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 

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 

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 

“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 

So you check their 80-trading notes

6 3/8 quarterly coupons. Callable. Mature 11/15/2022

Fuck. 

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 

Ok, maybe they break a covenant. Back to the 6 3/8 notes

Issued 11/1/2012. “Covenant-Lite”

FUCKFUCKFUCKFUCKFUCK 

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 

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 

Bubbling Crude
Oil, that is
Black Gold
Texas Tea 

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 

As of your reading, see for yourself:

NYMEX WTI Crude Oil Futures & OptionsTrade the most liquid crude oil markets in multiple contracts sizes and access global crude oil pricing and trading opportunities at CME Group.https://www.cmegroup.com/trading/energy/crude-oil/light-sweet-crude_quotes_settlements_options.html?optionProductId=190&optionExpiration=190-Z2#optionProductId=190&optionExpiration=190-Z2&tradeDate=04%2F24%2F2020

What are the greeks on being short that?
Delta: -.227
Gamma: -.017
Vega: -.176
Theta: +.003
Rho: -.165
See for yourself: option-price.com/index.php 

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 

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? 

The Blues Brothers - Theme from Rawhide (Official Audio)The Blues Brothers - Theme from Rawhide (Official Audio) From 'The Blues Brothers: Original Soundtrack Recording' (1980) Subscribe to The Blues Brothers YouT...https://www.youtube.com/watch?v=rtP7yH7l87w

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 

You get to hold that short for five more years

ONE THOUSAND EIGHT HUNDRED TWENTY SIX MOTHERFUCKING DAYS 

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 

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 

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 

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 

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 

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 

You will blame the Fed
You will blame dumb and/or greedy bankers
You will blame previous Fed presidents who have been gone for a decade
You will blame hopium-smoking bagholders
You will blame THE **UNCONSTITUTIONAL** FEDERAL RESERVE
You will blame Gypsies 

You will blame Arthur Fucking Burns
You will blame the UNSUSTAINABLE CREDIT BUBBLE INFLATING SINCE 1973
You will blame Marriner Fucking Eccles
You will blame the (((GLOBALIST CABAL))) propping up markets in service to the BIldburger Group
You will blame Armenians 

You will blame everyone except your own self for being unprepared for short gamma
And before you know it you will be mining ReichCoin with your 3rd videocard and shitposting Rothschild memes on 8chan while spaced out on the Xanax you stole from your teenage daughter’s hot friend 

A short gamma trade feels like prudently saving a little bit of money every day. Except every now and then a flashmob of delinquents pins you against a wall until each balltags you. They laugh because this shit is funny. Then they vanish with your wallet and the cops are nowhere 

The first time this happens, you roll around on the pavement for while until you can breathe normally again. You get up, think… well, that really sucked. But I’m still alive so it could be worse. Not like that’s going to happen again 

But it will, because you don’t yet know that in a short gamma trade this is now part of your life. It is thing that now happens to you randomly at a semi-regular rate 

The second time will provoke an existential crisis. Twice isn’t coincidence. Twice means this is A Thing Now. But twice is not enough to know at what rate. You’re in the random shock experiment that demonstrates learned helplessness. This is when you start abusing Xanax 

The third time is different. Three is a pattern. Patterns are psychologically tractable. Your anxiety gives way to seething anger that this grievous injustice recurs unpunished. You are Righteous Vigilante so this is the deepest cut. This is when you buy that 3rd videocard 

Now you face a fundamental life choice: Are you really a long theta / short gamma guy? If so, you just get used to the random violence. You never *enjoy* it, but it becomes validating. Withstanding random speedbagging of your sack proves your sack is plated with FUCKING TITANIUM 

You start mocking the delinquents to show them they can’t *really* hurt you. They don’t laugh as hard because they’re just stupid nihilist-phase teenage delinquents, not hardened psychopaths like you 

This long theta / short gamma life choice is much easier if you come from generational wealth locked up in a 60/40 portfolio in the trust fund that your father still won’t let you touch even though you’ve BEEN A FINANCIAL PROFESSIONAL FOR EIGHTEEN FUCKING YEARS ALREADY, DAD 

But if you’re going to stick to the long gamma style more appropriately suited to your personality, then you have to realize this may not be your trade

But you won’t

Because you had a brilliant idea 

You’ll no longer straight-short ShitCos riding out the string. You’ll buy puts instead. Long puts turns this into the exact long gamma / short theta trade that won’t reduce you to a flaming wreck of a human being that your wife divorces 

You will save your marriage
You probably save your sanity

You definitely lose your money 

Let’s flash forward a year. Red Dec TI is still $36.57
And the world is slowly proving you right. now trades for $1.37 a share instead of $1.85

But you’ve lost every penny on the trade

Because you bought year-away $1.25 puts on for 25 cents 

You weren’t stupid. You just made a rookie mistake
Part of you said is a fucking zero so this put is a 5-bagger
But that wasn’t really why
You punched in 566 days in place of 931 in the option calc and saw $0.79

Because you didn’t change the vol 

You got rolled-up. Vol roll-up, that is
is no longer a 23-delta, 30-vol option
It’s is a 19-delta, 35-vol option
Because actual options markets don’t bleed theta according to Black-Scholes-Merton
Because commodity futures get more volatile as they get closer to prompt 

The moral mistake you made was trying to end-around a cardinal rule of options trading:

Only he who wears the gamma collects the theta

Your trade is *inherently* short-gamma. *Someone* has to wear it. You decided it would be someone else but thought you’d make money 

You didn’t just pawn the theta to someone else. You *paid* someone else to take it. You *crossed the market* to do it

And the market you crossed twice was the options market for dying ShitCos. Those B/As are wider than GOATSE and you ought to feel like GOATSE when you cross them 

The real genius in all of this was the guy who sold you the puts
He sold *85-vol* puts
He hedged his delta by short-selling shares of
He rode that short (with a couple balltaggings) from $1.85 to $1.37

And now he owes you nothing 

He put on your trade, made the money you should have made, and YOU PAID HIM to do this

Because he is a hardened psychopath long-theta guy with a FUCKING TITANIUM sack

And you chose to be a neurotic pussy who overpays for tail risk 

And now his kids have fatter trust funds and brand new lax gear

That you paid for 

So. You want to mung ShitCo’s twitching corpse
Your options:
1: Short it knowing it will be 931 days until Justice
2: Short it in denial and become a divorced, anti-Semitic, Xanax-addled lunatic
3: Light your money on fire avoiding short gamma
4: Leave it be

Happy Hunting 

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