Wednesday, July 12, 2006

Turning Stupidity into Cash - Round 1

This DISCLAIMER applies.

$20 January '07 PUT
BID: 3.50
ASK: 3.70

Because the small investor must rely upon the options pits in order to benefit from the "naked short seller" scam, a lot of worthy candidates must be excluded from consideration. There are no put options that trade on the pinkest of the pink sheet disasters nor will you find options listed for most of the trash on the OTCBB.

But one excellent candidate that does have listed options is Overstock. In many ways, Overstock, with its CEO Patrick Byrne doing his best immitation of Chris Farly from "Tommy Boy" (except for the part where "Tommy" actually manages to save the family business), is a "naked short seller" poster child. There's not a quarter that goes by where "Dr." Burn doesn't manage to find an opportunity to lash out at those evil "naked short sellers" who have somehow caused him to miss revenue targets, stifle Overstock's growth, and trashed the company's working capital situation.

Overstock is also a great example of the odd pricing we will find in the options pits. The guys in the options pits are a lot smarter than you and me. They don't fall for this "naked short seller" nonsense which is evidenced by the pricing you see for the puts of companies we will target.

Take a typical day in the pits with a typical company like, say, Walmart. Walmart trades this morning around $ 46. With the common trading at that price, we then check out the January '07 calls and puts for the $ 45 strike. The calls are priced 3.60/3.80 , the puts 1.85/1.95 . With most stocks, you will find that the options pricing shows a bias that suggests modest gains are to come.

Overstock's options pricing shows an interesting contrast to typical options pricing. With the common trading just under $ 21, the January '07 calls and puts for the $ 20 strike tell a much different story. The calls are priced 3.50/3.80 , the puts 3.50/3.70 . The sharpies in the options pits are in on the joke. They know that the "naked short seller" excuse is nothing more than a poor excuse for executive ineptitude and have priced their instruments accordingly.

Unfortunately, this means it will be more difficult for us to make money off of these puts than we could otherwise make if the options were priced like those for "normal" stocks. But take some comfort in knowing that the "smart" money has voiced its opinion in the options pits. "Smart" money doesn't always win, but there's worse things you can do with your speculative capital than to put it with the "smart" money.

PRO: Decelerating growth, tenuous working capital situation. No ability to "brand" in a low-margin, cut-throat sector.
CON: "Fulfillment" business has relatively attractive margins and could be the focus of a shrewd restructuring.