Wrong! Take Two: Cramer's Rewrite of His Running with a Rumor Piece
By James J. Cramer
9/19/98 12:17 AM ET
Here is a piece that encompasses a lot of different trading styles I use and it was the most requested piece to rewrite. It is also extremely complicated, so I am going to overdo the explanations with the hope that you will come away with a better notion of how to use calls in volatile situations. Again, as many of you email me, I know of no other place to get this information other than here and NEVER recommend any books or options services as I have taught myself this stuff.
Man, rumors are tough to kill. And when you kill them they spring right back, like vampires in the night. (This market is heavily driven by rumors. On Friday I heard a half-dozen rumors about people, countries and firms going under. It is the stuff some people traffic in. I don't pass them on, but I do investigate them.)
Take Brazil. OK, I come in long 1,000 Telebras (TBR:NYSE ADR) September 60 calls purchased for a buck and a half during last week's Brazilian meltdown. (Here is a very typical example of a style I like to employ in extremely volatile situations. Telebras is one of the toughest stocks in the world to trade. It moves in three- and four-point increments and unless you have total conviction, you can't stay long it through that kind of pain, or short it, for that matter, although this country has been one unbelievable short since the Russian turmoil began.
When Telebras had gone down and down and down and down, I speculated first in the September 70 calls and then in the September 60 calls that are mentioned above. I spent $150,000 to get the right to the upside above 60 with these latter calls. I put it that way because very specifically I did not want any of the downside. Telebras, I believe, was completely mispriced in the mid-50s. Some of us were even joking about how cheap it was, with the punchline being that TBR could earn $50 next year! But I once owned shares in the Turkish telephone company that I bought at 70 cents a share, down from $1.40, and after the country devalued its lire five times in a few weeks, the phone company sold for 18 cents, so anything is possible when you are dealing with foreign currencies.
Still, Brazil is the ninth largest economy in the world, it is growing like wildfire, and the company is breaking up a la Ma Bell in 1984, so this seemed like a good trade provided the country did not devalue. No country ever says it is going to devalue, it just does it, and there was plenty of devaluation talk in the air. But by using calls I had quantified my risk right up front. Who knew what my reward could be.) Just trawling for a little compressed bargain. I am sweating bullets Tuesday about them though because it's an awful lot of capital to go up in Latin American smoke at the end of the week if nothing good happens. (I know I run a multimillion-dollar fund, but I also knew that I only had a week until expiration. I don't like to buy out-of-the-money calls to begin with, and I particularly don't like to buy out-of-the-money calls without some time to make them work. But Telebras is a "pumped" situation, meaning that calls are never going to be cheap because you have a volatility component to the calls that is off the charts. If nothing happens, these go out worthless. But then again, volatility says something happens and it did.)
The old gun-to-your-head tension again. (Options people constantly speak in these metaphors. A gun to your head is a short-time call, as in "why put a gun to your head, why not go out further in time?" I did not want to go out further because the October 60 call was about $7 and I did not want to spend that kind of money.)
Monday, in a moment of exasperation, I short 30,000 Telebras against those calls at 58 and change. This is an unhedged position until 60 (meaning I can lose money until the stock goes to the strike price) and then is a ratioed position, meaning that I will be short 30,000 Telebras below 60 versus being long 70,000 above 60, because that's when the calls kick in. (I love positions like this. If Brazil falls apart, I make some money on the short; if it hangs together and good news comes, I win on the long side.)
(I already tried to explain this somewhat during the week, but let's go slower and more thoroughly. One of the things I like to do with calls is use them to stop out shorts. In this tough tape I like to have a lot of shorts on. They allow me to do better on the down-200 days than if I were just straight long -- which I never am. But I am uncomfortable being naked short, meaning being unhedged against an upside explosion in a stock. I would never just be short 50,000 Telebras without calls above it, say, because I would so fear that a G-7 deal would be worked out that would send this stock back to much higher levels and expose me to sky's-the-limit-losses.
But if I have these out-of-the-money calls protecting me, I can put a short on and always know that I will be protected. I usually like to do it on some sort of ratio, meaning that I like to have some short against some more long. If I were to sell 100,000 Telebras short against 1,000 calls, that would be fully hedged. I could only benefit if the stock went down, as I would be in a one-for-one situation on the way up above 60.)
On Tuesday morning J.P.Morgan upgrades Telebras. (Firms routinely upgrade and downgrade stocks. Often they are not consequential. But this upgrade had some heft to it because the stock had been down so much.) I think this is a big call because Morgan knows a lot about international. I am hearing rumblings that the upgrade may be because of a deal, the line in the sand, and a possible giant credit line being extended to Brazil because no one wants Brazil to fall apart, except for maybe Jimmy Rogers, who knocked it unmercifully last week on CNBC. (See my line in the sand piece Tuesday morning.)
I tell my trader to buy back the 30,000 shares I am short, because I think that the upgrade will have impact, maybe to 60. (In other words, I wanted to take off the downside hedge. I was afraid that Telebras would ramp and I wanted maximum firepower, and I did not want to get caught in my one weak spot with this trade, which is a move to 59.75, say, where I am short and unprotected. Then I could lose both on the common and the call!!) But sure enough, the stock opens in Brazil down a buck, and I buy it easily. (This was incredible to me. I couldn't believe how heavily the stock opened. My trader was shocked, too.) Looks like another terrible day in the United States of Brazil! It is lower almost immediately.
By 9:45, though, it starts climbing, and I wait for the calls to get out of rotation (it takes 10 minutes for calls to get out of rotation after the opening of a stock) where I immediately sell a quarter of them to help pay for the position. That is typical of what I like to do -- take some of the cost off the table, so I won't have the dreaded wipeout. (The calls were at $2. So I take out $80,000 of my $150,000 cost. I did this, which in retrospect was Wrong, because I needed to worry less about the amount of capital involved. I wanted to play with "less of a gun to my head.")
At 10:00 I see Latin America flying and I am asking everybody what they hear. I get word back from Jeannie Cullen, my assistant, that there is talk of a $100 billion IMF credit line for Brazil. (This is amusing as everybody knows the IMF doesn't have that kind of money right now, but rumors don't necessarily have to smack of fact.) I immediately dismiss that, but the next thing I know Telebras is soaring through the strike (September 60) to 63. Someone else is buying this ^$*#*??$. So here I dump another 100-lot, taking in four bucks. (Now I have taken in $120,000, almost my entire cost, and I can now play. I can sit back and go for the long hit without worrying about a wipeout. This is really important to me psychologically. I want to be able to have enough of the cost off the table that I am playing with the house's money.) No sooner is the report back then Goldman is issuing a statement saying that the rumors of a big package may be false. (I really and truly believed that Telebras would start going down right then.)
I off-load another 100-lot quickly at 5. They are still taking the darn thing. (That means they are buying it. Take means to buy. Offer means to sell.) Next thing, the stock is cruising past 65. Goldman comes back and squawks that they have gotten in touch with the Brazilian government and they categorically deny any massive aid package. Now I sell 150, this time at 6!!!! (This persistent Goldman call turned out to be wrong, as we shall see.)
The stock starts going down and I quickly sell another 100 at 5.5, because, lo and behold, there are those Telebras September 70 calls I bought for a buck the week before when I was also thinking Brazil could rally. I never thought those would come into play (obviously, it turns out, the guy who sold them to me didn't know either). (What I meant by this last comment is that many of these calls were probably "shorted" to me. Meaning that someone out there -- I don't know who -- sold these calls expecting that Telebras would keep going lower. Some of them might have been sold against common on a ratio, but others were naked short, meaning someone was betting $1.5 to make $l.5 but might lose far more than that.)
Next thing I know, Soros is going to speak. I know he is Mr. Meltdown so I want to offload as much Telebras as possible. Now I know not only is there no aid package, but Soros will be waving the white flag of emerging market surrender. I quickly dump the rest of my calls on a slight scale, for about 7. Big hit. (I am now done with the September 60s. A worthless piece of paper going into the day has now been my best trade of September.)
Holy cow, Soros is even more bearish than I thought and there goes Telebras, trading up 10 to 69. Now I dump 500 of the Telebras 70s, paying for that whole position. No matter -- CNBC cuts away from Soros and Telebras rockets through 70, where I sell another 250. Only a matter of time before somebody figures out there is no multihundred-billion-dollar package; heck the IMF is broke for Pete's sake!!! (This was a dumb trade. I had written off these calls already, so the textbook, meaning my own personal nonwritten textbook, says you should let them go and see what happens. I didn't do this because I thought the Goldman denials would start having an effect.) More guys issue heated denials of any aid, but there is some vague cryptic Group of Seven statement about Brazil on the tape and I think, hey, enough is enough, and I sell the last September 70 calls, the found-money calls, as we would say, for 3. Book 'em, Danno. (Yes, I talk like that on the desk.)
(Found money is another option term for something that roars back to life that had been given up for dead. This trade was better than the first and it made the whole thing very profitable, but what I should have done if I really believed the rumors to be false was sell common stock short against the September 70 calls when the stock was at 73. That way if the denials turned out to be true I could profit from the quick reversal in Telebras below 70. Instead I took the premium way out.)
And what happens? The darn stock just keeps ramping. It roars again. Leaving me with simple October 100 paper that I paid so much for that I have already mentally booked the loss and now I am not so sure. Naked without my September paper.
Amazing. Never have I regretted such a big hit as I can't believe how much I left on the table through my homework on the denials.
What was really going on here? I think that the people who have been shorting these stock relentlessly panicked into covering. At last. This had been the big money trade of a lifetime, this short of Telebras. At the same time Telebras got so cheap that unless you thought devaluation was imminent, you could not afford not to be long it.
For me, I was a satisfied customer, only twice blasting Jeff for getting me to sell Telebras up seven, when of course, he did nothing of the sort, and I was just being mean.
When I was leaving the office I saw repeated denials of the giant bailout package. I thought for a second, if only I had not done any homework, if only I had not listened to the news or the brokers, would I still be long those home-run calls????
Nah, I wouldn't have bought 'em in the first place. (It turns out that a collection of American bankers were getting together that night to arrange a massive standby bailout plan. The buyers were dead right. The denials were dead wrong. This trade worked for the people who bought my calls because they had better information than I had. I was relying on the public denials, they were relying on the real information, which was that there was a deal after all. Them's the breaks. NEVER ever second-guess a winning trade, only a loser.) |
