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Saturday, August 3, 2013
When I first heard hedge-fund manager Bill Ackman was trying to raise $1 billion to purchase a single, unnamed stock... my first thought was: "Why not? It worked out so well the first time."
In mid-2007, months before the subprime bubble burst, Ackman raised $2 billion to buy another unnamed company... It turned out to be big-box retailer Target. And the fund subsequently fell 90%.
It's ridiculous... It's a sign of the top. I wouldn't have given Ackman a penny for this fund. But I was in the minority... He raised more money than he could spend, he said.
Before discussing Ackman's specific investment, I'd like to tell you something I find very interesting about Ackman...
He made a big deal about the supposed ethical shortcomings of a company called Herbalife. He pointed a finger at the folks who run Herbalife and called the business a pyramid scheme. He made fun of the fact that it sells lotions and potions in a network-marketing arrangement.
A lot of people disdain multilevel-marketing businesses. I understand that. They're not everyone's cup of tea. They're not mine, either. I would never be part of a multilevel-marketing organization, nor would I be a customer of a multilevel-marketing product. I'm not comfortable doing business in that way.
But I'm not pointing the finger at people involved in these businesses. Nor would I label them liars or pyramid schemers. Keep in mind, Herbalife is a company that's been scrutinized over the years by plenty of attorneys general and lawyers.
I felt like Ackman's stand involved some ethical posturing. He was holding himself out as a moral judge of another man's business. That really bothered me. I don't like people like that. And I wouldn't do business with them, either.
It's troubling that Ackman can so easily point a finger at Herbalife and say, "I don't approve of these people. And I'm going to try to hurt their business interests by publicizing the things I don't like"... that he can trash the company publicly simply in an attempt to make money as a short-seller. Yes, I'm aware he's donating any profits to charity... but that's beside the point.
In the meantime, Ackman has the gumption to do something preposterous... raise money from people (who really should know better) to buy a single stock.
When you start studying the economics of what he's doing, it's insane. He will charge a 2% management fee on whatever money he raises. Based on the $2.2 billion he invested in Air Products, that's $40 million right there. He made that for doing work on one stock, for making one stock recommendation. Plus, he will take a cut of any profits the investment returns.
So if he's right and the stock goes up, he stands to make hundreds of millions of dollars more in fees. And if the stock goes down and his investors are all wiped out – as they were with Target – hey, he just moves on.
And he can do it again – no problems... no qualms... no shame... not even a casual recognition that he's in a business that pays him in an absurd way.
I find the juxtaposition between what he was saying about people involved in Herbalife and how he conducts his own affairs to be startling.
Longtime readers know one of our favorite trading strategies is selling put options on high-quality companies.
A big component of trading options is market volatility... When volatility is high, the cash you receive upfront for selling your puts (called the "premium") increases. And the opposite is true... Low volatility reduces option premiums. (More on this in a moment...)
We've recently seen lots of volatility in the stock market... Microsoft dropped nearly 12% in one day. Facebook jumped 25% in one day. And video-game company (and Investment Advisory portfolio stock) Activision Blizzard jumped 15% recently.
With these huge swings, you'd think we would receive a large premium for selling puts. But that's not the case today.
The key to selling puts effectively is to never sell a put on anything that you wouldn't like to own at the strike price you choose. The only way you can minimize the risk is to only sell puts on stocks you'd be happy to own at strike prices you think represent a bargain to the stock's true value.
You should look for companies that have stable businesses, good margins, and good cash flows – just like you would for any long-term investment.
Then, the time to sell puts is when the Volatility Index (the "VIX") is high. The VIX is a measure of the available size of the book premiums. When investors are worried about the direction of stocks, they'll pay more for options that protect the value of their investments... So when fear is high, so is the VIX. That's why we often call it the market's "fear gauge."
If you want to be really successful as a put-seller, you need to be willing to sell puts when other investors are panicking. We saw a small panic in the markets three weeks ago when the market reacted to Federal Reserve Chairman Ben Bernanke's announcement that we'd see them taper bond purchases later this year. The VIX jumped from 12 to 21.
That's a sharp jump... But to put things in perspective, the VIX hit 80 in October 2008 (in the middle of the subprime crisis). That was the greatest time in recent history to sell puts. That's about the time I was writing my put-selling service, the Put Strategy Report.
Today, the VIX is at 12. I'd look to sell batches of puts when the VIX rises above 20. But remember, that increase in volatility can happen in a single day, so be aware.
Last month, politicians in D.C. passed the Living Wage Law, which mandates big business pays its employees at least $12.50 an hour... a significant increase from the current $7.25 federal minimum wage rate. (It's only applicable to retailers with sales of $1 billion or more.)
Wal-Mart, the world's largest retailer, said it would leave Washington, D.C. if the law passed. And lawmakers put Wal-Mart to the test...
D.C. City Councilman Vincent Orange, a lead proponent of the legislation, said, "The question here is a living wage. It's not whether Wal-Mart comes or stays... We're at a point where we don't need retailers. Retailers need us."
In response, Wal-Mart said it would abandon plans to build three stores in the area and "review the financial and legal implications" of not opening them.
This is typical... The people in government believe they can mandate income or wages. But you can't force an employer to raise its wages without offering some sort of incentive.
By the way, this is the same problem as the health care law. The government has decided everyone has a right to health care... but the government can't provide it. A doctor and a hospital have to provide it.
And the doctor and hospital have to receive some kind of incentive to do so. So the idea that you can dictate these benefits is always going to be flawed.
This kind of legislation will fail. And it doesn't provide any benefit to D.C. residents... It doesn't get them higher wages. It simply reduces the opportunity to get a job at all.
Porter Stansberry with Sean Goldsmith
Date Range:7/25/2013 to 8/1/2013
Date Range:7/25/2013 to 8/1/2013