Monday, December 28, 2009

New short position: UAUA

With the Nasdaq near a 14-month high, and the VIX near a 14-month low, I have been building a basket of out-of-the-market puts on financially-distressed stocks drawn from Short Screen's screener1. Today's addition to this basket are the $6 strike, JUN 10 puts on United Airlines parent UAL Corporation (Nasdaq: UAUA), UALRK.X. I bought a few of these today at $0.40.

Warren Buffett famously noted how awful airline stocks have long been as investments, quipping,

I like to think that if I'd been at Kitty Hawk in 1903 when Orville Wright took off, I would have been farsighted enough, and public-spirited enough--I owed this to future capitalists--to shoot him down. I mean, Karl Marx couldn't have done as much damage to capitalists as Orville did.

Despite Buffett's old admonition, investors have bid up shares of UAL to more than four times their low for the year in June. Like those of many risky companies, shares of UAL have been buoyed by the liquidity-fueled rally this year, despite having persistently weak fundamentals. In addition to having an Altman Z"-score of approximately -2.1, according to Short Screen's calculator (scores below 1.1 indicate distress, according to the model), UAL has lost money in three of its last four quarters, and has a current ratio of approximately .68, indicating that its debt burden is a near-term challenge as well as a longer-term one. Over the last year, according to Nasdaq, there have been 7 insider sales and no insider buys. I expect shares of UAL to decline when the euphoria of the current market rally fades and reality sets in again.

1For those unfamiliar with it, Short Screen's screener uses the Altman Z-score model (for manufacturing companies) and the Altman Z"-score model (for non-manufacturing companies) to rank stocks according to their level of financial distress. In its initial test, the Altman Z-Score was found to be 72% accurate in predicting bankruptcy two years prior to the event, with a Type II error of 6%. In a series of subsequent tests covering three different time periods over the next 31 years, the model was found to be approximately 80-90% accurate in predicting bankruptcy one year prior to the event, with a Type II error of approximately 15-20%. For more detail on the models, and on how Short Screen's screener works, please see here.

1 comment:

DaveinHackensack said...

These puts will likely expire worthless. Partly, because the underlying stock has mainly gone up since I bought them, but mostly because I foolishly (and cheaply) bought puts that were too far out of the money here. As I mentioned today on the new blog, when buying puts to bet against a security (as opposed to simply hedging), it is better to buy options at the money or close to the current share price of the underlying. Eric Falkenstein has noted that these sorts of puts are less risky than far out-of-the-money puts.