TBT allows investors who are restricted to only hold long positions in their retirement accounts to trade on their conviction that the long bond must fall. Afterall, our spendthrift politicians won't be able to sell anymore paper to the Chinese so interest rates must increase. We are doomed. If you believe that and are not willing to explore the dark side of deflation, then stop reading. I recommend buying 2012 TBT puts that have a $40 strike. Current TBT price is $51. This is an insurance policy for equity investors and a contrarian speculation. The gradual decay of TBT from dividends and internal leverage will bring TBT's price to the $40 strike price in 1.5 years assuming no change in interest rates. The premium for the put should be in the $4 range at that time, and you'll have a 33% total gain. That is the base case. Appreciate the long bond's powerful inverse correlation with the equity markets. If the stock market collapses, interest rates for government bonds would likely decrease rapidly as they did in 2008. The 52-week low for TBT was $35, if that type situation returns you will have a very quick 300-400% return on your position. So far we've outlined 2 of 3 likely scenarios. No change in long term interest rates and you earn 30-40%, long term rates drop and you earn 300+%.. what about the other scenario? Here are my best guesses: long bond rate in 1.5 years: Investment return from this position: 2% long bond rate = 900% total return 3% long bond rate = 460% total return 4% long bond rate = 46% total return 5% long bond rate = -90% total return 6% long bond rate = -98% total return So, size your position carefully! This is not your father's oldsmobile. TBT is leveraged inverse bond fund. It is shorting 20+ year treasuries that are yielding roughly 4% right now. It was introduced in May 2008 with a $70 price tag. At that same time, the ishare for treasuries(TLT), basically the opposite without leverage, traded at $89. Since that time interest rates have fluctuated, inflation expectations have gone up and down, fear and greed have come and gone, etc. Currently, interest rates on long bonds are basically the same as they were in May 2008. So, where is TLT now trading? It's trading at $91 (up a mere $2) and it has paid out about $6 in dividends. In a perfect world you'd expect a portfolio full of TBT shares (remember, 2x the inverse) to be down 2x the amount of dividends that a portfolio full of TLT shares has paid out, and down another 5% to account for the $2 in appreciation by TLT. If that were the case, then TBT would be trading at $58, but instead it is trading at $51. There's probably a term to describe that $7 loss (13.7% total, 7.6% annualized). It's probably due to volatility, internal leverage, administrative expenses, advertisements in Barron's magazine, etc. Whatever it is, it will likely continue being a drag on TBT's share price. It is old news that these leveraged inverse ETFs are not the most efficient vehicles in the world. Their value to the investment community may be legitimate since they are convenient and they are allowed in retirement accounts (whereas shorting TLT may not be). The price of the put, as calculated by some nobel prize winning formula, doesn't appear to be take into account the automatic, predictable decline in the value of the underlying. Most Black & Scholes models have an input for dividend that is used to calculate the correct option price. The inputs are dividend, risk free rate and volatility. TBT pays no dividend per se but the price is predictably erroding as if it were paying a large dividend. So, roughtly speaking, TBT will decrease by the following amounts on an annual basis: 4% for the treasury coupon, doubled because of leverage = 8% 7% for the volatilty & leverage premium (established above). I suggest you use an estimated holding period of 1.5 years of the 2 year life for estimation purposes: Over 1.5 years that gets you a 22% loss in a up & down market market where interest rates fluctuate like they have been fluctuating. 51 x (1-22%) = 39.78 A TBT put option with trading at near the underlying share price, with 6 months left, trades at around $4. If the risk free rate goes up or if volatilty goes up then that could be substantially more. Other positive factors for this trade: Short term interest rates and volatilty are low - increases put premium if they increase, increase the cost of leverage in the TBT etf and reduce it's efficiency. Long bonds post a -16% return in 2009. That is the worst return they have ever posted in their history, to be fair, it comes on the heals of many great years for long bonds. Still, looking at long bond returns going back to the great depression, we don't see too many -16% returns followed by big negative returns. (disclaimer: I'm not an economist, I'm just saying -16% was an outlier and, when convenient, I believe in dead cats and reversion, stuff like that).
Rough interest rate scenarios: Long term rates rise and stay high (this is the consensus view); you likely lose most of investment. Size your position accordingly. Long term rates flat, or volatile as they have been; "natural decay" knocks over 20% off share price leaving the underlying trading at the strike with 6 months remaining option life. You post a 33% total return. Long term rates fall; an instant 300-400% return if long bonds spiked like they did in 2008-2009. This makes it a great hedge for equities. Thinking of it in terms of equities and portfolio theory may make you more comfortable with the fact that you could lose your entire investment. The returns of long bonds have been inversely correlated to the returns on stocks. That correlation has been getting stronger. If you look at the returns over a 30 year period, there appears to be none. As you look at more recent periods, the reverse correlation gets very strong.
-1 is perfectly inverse correlation 0 is no correlation 1 is perfect correlation. Bear case: If interest rates rise substantially then your principal is toast. There are a million, no make that 10 trillion, reasons why interest rates have to rise. My point was that if they don't rise you will make a 40% return. If they do the opposite, as they did in late 2008, you could have a 10 bagger while the rest of your portfolio gets squashed. |
Tuesday, December 29, 2009
idea #2 2012 TBT puts
Tuesday, December 15, 2009
Walmart Leaps, idea #1
Long leaps expiring January, 2012, $30 strike Currently trading at $24, vs $54 underlying stock price
Multiples for underlying:
Trading at 15.3x earnings, vs. 7 year average of 20x earnings
Trading at 3x book, never traded this cheap (on average annual basis). 7 year average is 4.2x
.5x p/sales per share, vs .7x p/sales per share, 7 year average
Meanwhile, revenues and margins were stable throughout recession. How can the market be predicting they're going to go down from here?
Walmart underwent multiple compression as did all risky assets. Yet, it was operationally one of the most successful businesses during the recession. As multiples of all risky assets and yields of corporate bonds regained ground during market recovery, Walmart did not gain much. It should have recovered it's old multiple at the very least. It should be the star of the show instead of a laggard.
Technical Positives:
9 analysts upped their 2011 estimates, vs. 1 analyst lowering estimates.
During the nastiest times of the financial collapse the shares traded at a low of $46, only $8 below current price, 14.8% below current share price.
There are consistently less shares outstanding every year. 11.7% less shares outstanding now than there were 5 years ago, yet revenues, gross profit and net income have increased dramatically.
2004 revenues : $258 billion 2009 revenues: $403 billion
2004 shares outstanding: 4.3 billion current shares outstanding: 3.8 billion
Stable margins!
The share price is basically the same as it was in 2004.
A lot of good, long-term investors are buying. Buffett just doubled. Either Walmart is a coiled spring or, as Mr. Market looks at Walmart, something bad is going to happen to their revenues/operations.
Market fears:
- channel check product of grocery areas (~30% of revenue) seems to be very "proctor & gamble" like in product mix. Big name, value added type grocery products that are not healthy and out of fashion. Will the consumer wake up to healthy eating ideas that don't include value added, heavily branded products like rice-a-roni, potato chips, and soda pop? Will they wake up out of necessity and start cooking from more basic ingredients (plain rice & salt instead of rice-a-roni,?) - 70% of their products are made in China as reported by some detractors of walmart. Dollars are leaking out of our country and outward appearance is that the biggest, fattest conduit for the leakage is Walmart. Zillions of corporations have manufacturing based overseas that profit from the same cheap labor, Walmart is just the distributor. Amazon sells the same stuff and trades at 40x – 70x earnings, vs. Walmart's 15x earnings. Everything is made in China . Walmart is the face of this issue. Walmart has an unsustainable 12,500 mile supply chain. - Labor issues. Walmart just settled a $40 million lawsuit in the N.E. for locking employees in the store. More lawsuits will come? Can they be material or just psychological? $40 million per state, 49 states left (at worst) is $1.9 billion. Walmart sneezes $2 billion. Fascinating history of walmart litigation. Apparently Walmart is sued 2-5 times per business day somewhere in the United States . http://www.wal-martlitigation.com/99verdic.htm
Catalysts
Buybacks and free cashflow Continued interest in value investors Flight to safety Inflation protection Walmart has pricing power and shelfspace to take advantage of alleged "over capacity" in economy.
Why Leaps:
Black scholes option value calculator says that if market volatility doubles, and share price collapses to 52 week low, then calls will go down in value by 19.3% (vs. 14.8% for the underlying). Market volatility was over 4x higher than it is now during the collapses in share prices last spring & fall, so the value of the calls will likely go down by even less than 19.3%.
Purchasing the underlying stock for cash gives you a 1:1 return. Purchasing $30 calls for control over the equivalent amount of shares, and keeping the remaining cash on the sidelines, gives you a 1:.58 upside/downside scenario in the above mentioned case. You will suffer 58% of the loss (but still capture 100%) of the gain if we encounter the same selloff we had last fall, with only half the volatility.
Negatives & Uncertainties:
Walmart has been getting cheaper. My valuation based on multiples isn't useful in determining a bottom since every year it was cheaper than the previous year. Walmarts dividends are steadily increasing, which is bad for call holders.
Why is the market letting it get cheaper? When will the bottom be? Why isn't the market recognizing walmart's overwhelming success during the recession?
Healthcare uncertainty. My understanding is that it's just as likely to be helpful for walmart, as hurtful.
Great VIC writeup on WMT in Nov, 2009 references underlying real estate value compared to a reit, improving employee base, smart management decisions, and rapidly improving roi compared to comps. |
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