Thursday, December 24, 2009

What would have been spectacular timing

A day late. Damn. Details later.

Update: Here are the details I didn't have time to write about earlier. Sorry about not writing this out earlier, but it takes me a while to write these posts, and I just didn't have the time to do that earlier today, so I posted that as a placeholder.

As I mentioned in a previous post, the biggest risk I see with Alloy Steel International (OTC BB: AYSI.OB) is, "a nasty exogenous event (e.g., a big fall-off in Chinese demand for industrial commodities1)". For companies that have options traded on them, you can of course buy puts on the company to hedge your position. How, exactly, to do that in an optimal way is what the next subscription-based site, Portfolio Armor, is about (Portfolio Armor isn't live just yet, but that's its logo above2). Portfolio Armor's proprietary algorithm tells you exactly how many of which put options to buy to give you the level of protection you specify at the lowest cost.

Of course, Alloy Steel doesn't have any options traded on it, so there would be no way to use options to hedge against any purely idiosyncratic risk, but there are ways to hedge against the exogenous risk. I thought about this last night and figured that a way to do that would be to buy puts on a steel company with significant exposure to China. Then I figured, instead of using just any steel company with exposure to China, why not try to find a financially distressed one? I found just such a company using the screener on Short Screen. To give me a rough idea of how many of which of that company's puts to buy to hedge my AYSI position against the specific exogenous risk I mentioned above, I e-mailed my developers at around 8:30 am, asking them to run the algorithm on the steel company I found. When I got the answer from them later, I went to pull up the option and learned that the financially distressed steel company had announced a secondary offering at around 9am today, and on news of that dilution the stock dropped more than 20%, and the optimal put contract spiked more than 50%. Too bad I didn't think of this a day earlier.

1That's the big question. We presented the positive view on China this post back in September, "China's new self-propelled economy", and the editors of the FT presented the scary view in this editorial last month, "The cost of China’s excess capacity". In a nutshell, the positive scenario: China's big stimulus this year has helped transition its economy to one fueled more by internal demand, in which case there should be continued growing demand for industrial commodities to build infrastructure in underdeveloped parts of China, manufacture first refrigerators for rural Chinese, etc. And the negative scenario: China's stimulus has been mainly hair of the dog, propping up an unsustainable status quo relying on massive trade surpluses that over-extended Western consumers can no longer support.

2Recall our discussion in this recent post of the initial challenges in coming up with this logo.


Homer315 said...

want to share which company it was?

DaveinHackensack said...

Not just yet, Homer. I may still buy puts on it.

Homer315 said...

I understand.