TTI Is Carl Icahn?… and other updates

LOL I wish.

But surely the coincidence is uncanny?!

In my earlier portfolio update post a couple of weeks ago (Portfolio Updates – 11/09/2016), I wrote about my options in Chesapeake Energy. Let me quote partially:

“…..The magnitude of the rise has been so damn crazy, that my call options at $7 got exercised…..

Now, I am not overly worried about CHK though, as IMO, the share price will drop again and I have now swung to selling put options.

When markets open on Monday, I really hope CHK drops drops drops, so that I can sell put options again, and hopefully they get exercised <$7, netting me a nice differential in the price, + premiums when my put options were sold earlier, + premiums when my call options ARE sold on Monday.

For now, it’d be really really nice if CHK drops to say… $6 or so. Then of course, please start rising after that to infinity.”

well, literally on the next day (12/09/2016), this guy sold down more than half his enormous stake in CHK at around $7. For tax reasons, he said.

The timing is absolutely uncanny. Either:

1. TTI = Carl Icahn
2. Carl Icahn is a fan of SG TTI
3. TTI lucked out

No prizes for guessing which is the correct answer.

CHK share price has responded accordingly:

So has TTI.

I’ve swung to selling put options like I said I would, and collected fat juicy premiums. 1 bunch of those options got exercised, and I’ve ended up buying back at a lower price, whilst collecting premiums several times (many expired)

That was immensely satisfying.

In fact, the premiums alone paid for my recent family holiday. So…Thanks, Carl. Now, please give me a month or so, then go buy back what you sold.

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Ever since I’ve sold my major holdings in Hock Lian Seng and Metro Holdings, I’ve been looking out for a place to deploy capital, partially or fully. In the past week since returning from a long trip, I’ve been getting up to speed on my research.

I’ve come to realize that there’s ALWAYS something more to learn about a company that I’m analyzing. Each time I think I know all there is to know, if I do go back and start asking questions and poking around my thesis, I always come up with more questions, which in turn leads to more questions and more work. Kinda like nuclear fission.

In the past week, I’ve been trying to figure out how a company capitalizes borrowing interests. Thus far in my investing experience, all borrowing interests have always been expensed, i.e. they are recorded in full in the period that they are incurred.

This company that I am researching on, capitalizes them. Nothing wrong with that, just that for someone who is not accounting trained, trying to trace the multi year data in the income statement and balance sheet is a major headache.

I’ve since come to the conclusion that the answers to the questions I have… cannot be found in CONSOLIDATED financials. So unless I am working in the accounts department of the company, there’s no way I’d know.

I think their IR is pretty bemused about this dude asking them weird, micro-specific accounting questions. Or maybe the questions are noob questions, and they feel irritated about giving accounting lessons to a, as yet, non-shareholder.

Still, nothing is ever wasted. I feel like my knowledge got upgraded. I am pretty confident that most of the current shareholders do not know about the capitalized interest costs, much less try to track them. It may not be relevant per say to the investment, but any extra knowledge gleaned that the general markets do not know/bother to know, IMO, is a competitive advantage. It’s use may come later, perhaps much later in a separate situation altogether.

I’ll probably post my investing thesis when I am done accumulating. The problem is my work spans several months, and my thoughts are in depth. Putting all that in a coherent way for others to read easily, simply takes time to organize. It’ll probably be awfully long too.

I’ve had feedback that I shouldn’t break up my investing thesis into “parts”, as some readers who have read part I, feel frustrated at having to wait for part II. Or maybe when they read part II, they would’ve forgotten part I and have to go back? Anyway, I’ll keep that in mind.

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I’m just awaiting some answers, and then I should feel confident enough to accumulate. I’ll probably allocate something between $100k-$200k to this, pending the liquidity. I’m in no hurry to accumulate, cos my view is tending towards the bearish side for the rest of the year. Anyway, the liquidity ain’t that high for me to accumulate quickly.

In the past month, I’ve made some cosmetic, small divestments in my existing holdings, whilst still retaining the main bulk.

Reason for that is simply portfolio management. Some holdings are disproportionately large, and I’m taking some profit off the table to trim it down. For another holding, it’s taking some losses off the table.

Anyway, I think it’s time to move on to another company to analyze. (Like I said, each time I go back, I always find more things to find out about). This is actually a fairly easy/ non-complicated company to study and I took 3 months. Gotta buck up.

I’m open to suggestions / requests to analyze companies. Please feel free to drop them my way. But of course, please make sure it at least remotely fits the bill of “deep value”. For eg. if it’s P/B is >3, I don’t usually bother to look further.

Oh, and if there’re any accounting experts who’d be kind enough to lecture me about the capitalization of borrowing costs, please drop me a mail.

Lastly, I’ll end with a pic of the amazing library I said I’d visit in Stuttgart.

Oh for those who’d be in Austria, I’d highly recommend this:

Eisriesenwelt Ice Cave – The largest Ice Cave in the world.

It’s a crazy climb up to reach just the entrance as you can see, and this photo is taken AFTER a 20 mins drive uphill, a 30 mins hike AND a steep cable car ride up, and there’s another 1hr+ of climbing inside the caves, so don’t plan on doing this during retirement. Your wallet may permit it, but your body sure as hell won’t.

No photos are allowed inside, but here’s the wiki link about it:

https://en.wikipedia.org/wiki/Eisriesenwelt

With regards to travel, I always tell my friends:

When you’re young, you have the time and the energy, but no money

When you’re middle aged, you have the energy and the money, but no time

When you’re elderly, you have the money and the time, but no energy

There’s just no ideal time, (unless you are born wealthy), so you just have to start ticking off your bucket list NOW.

TTI’s Basic Guide To Stock Options

I get quite a bit of interest from readers regarding stock options, so here’s a simple guide on stock options, and my experience thus far with them.

Stock options are derivatives, meaning their value is derived from something else. You can have options on… well, stocks, on commodities, on indices, on almost anything under the sun as long as there’s a tradable market in it.

An option  is exactly that. You either get (if you own the option) the option to buy or sell something at a certain price, within a certain time frame. If you sold the option, you are giving the counterparty the option to do exactly that.

Broadly speaking, there are 2 types of options you can enter into: CALL options and PUT options.

Call options are a bet that the underlying derivative value will go up, while put options are a bet that the underlying value will go down. An easy way to remember is to remember that you CALL UP somebody, while you PUT DOWN the phone.

So there are a few parameters to every option:

1. The underlying derivative.
2. The price at which the option is exercised
3. The time frame/period during which the option is valid
4. Call or Put option
5. The premium or price of the option

So for example, if I bought/own a call option for company ABC at a strike price of $30 which is valid till say 23rd Dec 2016, the option will look something like this:

ABC Dec23’16, $30 Call

ABC is (1.) the underlying derivative

Dec 23’16 is (3.) the time frame

$30 is (2.) the exercise price

Call is (4.)

and (5.) is simply the price at which this option is trading at.

So as you can probably tell by now, there are many options depending on the various variables. These are listed in an option list. This is an example of an option list:

So basically if you are bullish on ABC, you could either: BUY call options, or SELL put options.

And if you are bearish on ABC, you could either: SELL call options, or BUY put options.

Confusing?

Let’s use the example above. Assuming ABC is at $20 now, the premium for the above call option is $1. I think ABC will go much higher by the 23rd Dec 2016, so I decide to buy this call option.

On the 23rd Dec 2016 (btw, options expire on Fridays usually), my option gives me the right to buy ABC at $30. If ABC is now at $40, I still get to buy it at $30, while it’s market value is $40.

So my profit would be $40-$30-$1 (the premium I paid earlier to buy the call option) = $9.

There are a variety of different combinations to work out because of the numerous variables. There are also correspondingly, several options for each derivative.

This is a very very simplistic way to put it, in reality there are several other variables like delta, sigma etc. I spent a long time understanding them, but in reality, I don’t think they’re very important at all.

Perhaps the only other variable that’s important is the Implied Volatility (IV).

The IV tells us how volatile the price of the underlying derivative is. Generally, the greater the IV, the greater the premium for the option, since theoretically, there’s a greater chance that the exercise price will  be met (since the price jumps around so much)

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My Experience

Most of my option activity revolves around selling.

I sell both Call and Put options, but never naked calls. (Naked calls = selling call options when you don’t actually own the derivative)

So what does that mean?

Say you like company ABC and would like to buy shares at $20. It is now at $25. You can key in an order and hope that the share price drops to $20 right?

Alternatively, what I do, is to sell Put options at $20. Basically, it’s a contract that gives a counterparty the right to sell the shares to me at $20. That’s the price I want to buy it at anyway right?

So at the end of the period, if the price is at $20, great. I buy it. And keep the premium of the option.

If the price is ABOVE $20, the contract expires and becomes invalid, and I get to keep the premium that I sold the contract at. I am free to sell another contract and keep the premium again.

Both ways, I keep the premium. This means that the actual price that I bought the shares at, is not really $20, but rather ($20 – premium of the option that I sold at)

Selling call options is the exact opposite. If you own shares in ABC, and you think a fair value to sell at is $40, you could sell options with exercise price at $40. If the premium is $2 for example, you get to keep this $2 if the price is below $40. If the price is above $40 when the contract expires, you sold your shares at $40 + $2 = $42.

Now obviously there are many variables at play here. That’s what I actually like about it. With this many variables, there will be bound to have mis-allocations in value in the options market. If there aren’t that many variables, the market gets  pretty efficient and it becomes hard to find any opportunities.

In options, I can find instances where the premium is ridiculously high for the particular contract, when the contract perfectly plays into my investing thesis. This is because the premium is affected by so many factors such as the IV mentioned, and of course, the “demand and supply” of the contract, the sentiment revolving around the underlying derivative etc.

IMO, this is really as much of an art as it is a science.

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My Results

It is hard to measure the results EXACTLY, since some options get exercised, while most do not. The exercise price vs the actual price varies, and this gap changes all the time.

If I look simply at the “cashflow”, based on an invested sum of approximately $160k USD, I receive approximately $1.5k USD worth of premiums each week.

That means that every Friday, if nothing gets exercised, I pocket $1.5k. Not too shabby.

Assuming 52 weeks a year, that works out to a yield of 48.75%!

Of course, that is a rough estimate as like I said, sometimes they get exercised.

Because of the numerous permutations, I don’t rely on the broker’s system to keep track of my options. I keep track of them separately on an excel sheet, complete with the cash holdings (it gets complicated when forex is involved)

A snapshot of a part of my recordings in 2015 looks something like this:

It’s colorful because I use colour to indicate when the same option gets covered.

Sometimes the yield is really delicious when there is misallocation of risk. For eg. During the Greek debt crisis last year, when there was constant talk of Greece leaving the EU, the options on “GREK” (Greek stock index ETF) gave very good yields due to the very high IV. There were some instances where I could get 15% yield in a single week!

Kinda ironic that just a year later, it’s Britain who actually left EU while Greece is still hanging around.

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I’ll end this simple guide by trying to explain something that I have gleaned from my personal experience. Hang in there as it gets a bit messy and complicated here.

Assuming you think company ABC’s share price is going to drop, and you decide to buy put options on it’s share price. Let’s say the share price is currently at $8, and you decide to buy put options with a strike price of $1.

This means that you have the right to sell the shares at $1, in other words, the option would be profitable or “in the money” only if the share price drops < $1.

Because when it is <$1, you can buy shares from the open market at <$1, and exercise your option to sell at $1.

Logically, as the share price drops towards $1, the premium for the option increases, as it is increasingly likely that the option becomes “in the money”.

Assuming you are right, and the share price started dropping, and it looks like the chart below:

Question: At which point would the premium for the put option be higher? When it is $5 or when it is $3?

Again, logically, the premium would be higher when the share price is at $3, as $3 is closer to the $1 exercise price, whereas $5 is further away.

BUT in my experience, there are many instances where it is actually higher at $5!

Why is that so?

This is because as the share price is dropping steeply, at the point where it is $5, the general participants of the  market have no idea how the share price would behave. They worry that it’d continue it’s steep decline, and maybe even hit $1 on that same session.

At $3, the share price has started leveling off, and the panic has subsided. Perhaps the technical guys determine that that’s a floor for the share price.

The corresponding demand for put options when there’s panic at $5, results in higher premiums for the option, even though it makes more sense for the premium to be higher at $3 than at $5.

This is just 1 of the example where I think there’s some mispricing to take advantage of. Of course, in the above example, we didn’t take into account many other variables such as the all important time factor.

If the option is about to expire say tomorrow, the option will behave very different from an option which is about to expire in a month.

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Addendum

Most recently, I’ve sold a bunch of put options on Wells Fargo (WFC), with strike prices of $45, $44 and $42. The share price has been beaten down greatly with the recent multiple accounts scandal, which I view as temporary.

I used to own WFC in the midst of the GFC back in 2009/2010. I got it then at a measly $9, and sold at $14 and was really proud of myself… well, not too long ago it was around $50 so I guess I really missed the boat on this.

Anyway, having done rigorous analysis on WFC earlier, it allows me to capitalize confidently now in the midst of all the hype, which I consider to be temporary.

If the options do get exercised, that’s fine with me. If not, the premium is nice and fat and juicy with the volatility.

The options all have a short expiry date of between 1-2 weeks, and I’ll considering rolling them over for more premiums when they expire.

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I’ll end this simple guide with a nice scenery pic. It’s really surreal to be writing about options in such a place. Also a bit amazing that I get excellent internet connectivity here, right in the middle of wilderness.

Multiple valleys surrounded by multiple mountains.

As always, have fun hunting for value.