Tavakoli Structured Finance LLC

The Financial Report

By Janet Tavakoli

Facebook: The Long and the Short of It

Facebook stock is at a record high: 103.94 as of the close Nov 4, 2015.

I am a long-time critic of Facebook’s funny numbers. (See: “Facebook: Soaring Fraud and Decelerating User Growth” – Nov 26, 2012, and “Facebook’s Fake Numbers: One Billion Users May Be Less Than 500 Million.” – December 11, 2012.)

I disliked Facebook’s IPO “disclosures” so much, that I bought puts on the stock and monetized them at a profit. The Wall Street Journal included me in an article when FB shares were off 24% after the IPO. (“Investors Best on Facebooks Fall,” Kaitlyn Kiernan and Johathan Cheng, Wall Street Journal, May 19, 2012.)

I took the profits and bought more puts with the profits. I gave back my profits. When you buy a put because you have a negative view on a stock, you can only lose the premium you paid. If you should be so lucky as to have a net profit and then reinvest those profits, you will keep more of your original profits if you pull the rip cord when the trade moves against you. Likewise, you do not need to reinvest all of your original profits. Never bet more than you can afford to lose, and even when betting realized “windfall” profits from a previous trade, realize that you are betting your own money.

First Rule: Control Your Losses

Selling stocks short is riskier. (I do not short stocks in my personal portfolio.) John Templeton, a skilled short-seller famous for his long-term investing, had a rule for short-sellers: control your losses. His second rule: remember the first rule.

During the 1999/2000 tech bubble, Templeton sold tech shares short just before the expiration of the insiders’ lockup period on the theory that insiders would take profits on overheated tech stocks, and he would make a quick profit during the heavy selling. He decided to short tech stocks with prices that had tripled or more from the initial IPO price. John Templeton found eighty four that matched his criteria and bet $185 million of his own money.

Templeton ignored his negative views on a company, and instead focused on the price action. If the stock rose, and the trade moved against him, he exited at a pre-established price to cut his losses. Moreover, if the stock had a strong price rise coming out of the lockup, he covered fast. There would be time to figure out why later. First, he controlled his losses, because just when you think a stock cannot go higher, it does.

He also had a rule for profit taking. When the stock price lost 95 percent of its value, or when it fell below a PE of 30 based on trailing 12 months’ earnings per share, he took profits.

But it wasn’t easy. Did he make billions? No. Executing short-selling strategies is easier on paper than it is in real time. Templeton risked $185 million and made a profit of $90 million.

Note: In 2009, Loren Templeton of Templeton and Phillips Capital Management was kind enough to give me a copy of Investing the Templeton Way, a book she co-authored with Scott Philips, her husband and partner. The information above is based on their description of Templeton’s strategy.

Structured Finance and Collateralized Debt ObligationsWhy Shorting the ABX Was a Great Trade

The famous short ABX trade, aka the big short, cost very little to carry, and the fraud-riddled fixed income securities—referenced by the derivatives—were issued at par. The underlying securities were only going in one direction: down.

See: Structured Finance & Collateralized Debt Obligations, Wiley, 2008.

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