This is an actual conversation I had with the most prolific blogger I know, Felix Salmon. He has been churning out material about the JPMorgan takeover of Bear Stearns. He helped me better explain why Bear Stearns was trading over the JPM buyout price of $2.00 a share. He used our discussion to produce a well thought out explanation of how Bear Stearns equity might function as a CDS proxy .
My position disclosure at the time of this writing is at the bottom of my blog entry.
neubert (11:41:39 AM): fun day yesterday.
felix (11:42:01 AM): hoo yeah
felix (11:42:09 AM): do you still have your BSC @ $7?
felix (11:42:19 AM): I hope you didn't take my advice to sell @ $4!
neubert (11:42:31 AM): sold calls on at struck at $10 for $2.25.
felix (11:43:04 AM): when?
neuber (11:43:25 AM): just now
felix (11:44:04 AM): expiry?
neubert (11:44:12 AM): oct and april
neubert (11:44:15 AM): seemed like free money
neubert (11:44:41 AM): I was thinking of selling some call spreads too. Hard to believe this deal will get
repriced.
repriced.
felix (11:44:42 AM): god knows. I'm putting up a post about it now
neubert (11:45:18 AM): Jaime Diamond took the U.S. taxpayer and Bear Stearns shareholders for a ride.
Good for him. Bad for us.
Good for him. Bad for us.
felix (11:50:44 AM): http:
//www.portfolio.com/views/blogs/market-movers/2008/03/18/open-questions-about-the-jp-morgan-bear-stearns-deal
//www.portfolio.com/views/blogs/market-movers/2008/03/18/open-questions-about-the-jp-morgan-bear-stearns-deal
felix (11:52:26 AM): also, you saw that Jim Ledbetter is going to be the editor of Slate's upcoming
business site?
business site?
neubert (11:54:35 AM): nope.
neubert (12:20:28 PM): https://thepanelist.net/Neubert%27s_Trades/Neuberts_Trades/_20080318846/
felix (12:21:44 PM): wait, this is BSC equity as some kind of weird proxy CDS?
neubert (12:22:35 PM): yep
neubert (12:22:38 PM): thought you'd like that
neubert (12:22:44 PM): Evil huh?
neubert (12:23:51 PM): Am thinking about covering the April 10 calls I sold 40 minutes ago at
$2.25 at $1
$2.25 at $1
felix (12:24:01 PM): I still don't see how buying equity protects a bondholder, though, especially if the
alternative to a deal is bankruptcy proceedings
alternative to a deal is bankruptcy proceedings
neubert (12:24:33 PM): It's not bankruptcy immediately. You are thinking too long term. Also,
in bankruptcy equity has value since it can hold up proceedings
in bankruptcy equity has value since it can hold up proceedings
felix (12:24:46 PM): wait, the stock went up and the calls went down? Truly this is a crazy market
neubert (12:25:05 PM): no. I sold calls when stock was at 8. now it's at 6.32
felix (12:26:07 PM): walk me through this, I really don't understand how equity is a proxy CDS
neubert (12:27:09 PM): not exactly a proxy CDS. But think of equity as an option on the
assets of the company. Higher uncertainty means the equity has more value just like an
option. (even if the expected value of the assets is lower)
assets of the company. Higher uncertainty means the equity has more value just like an
option. (even if the expected value of the assets is lower)
neubert (12:27:34 PM): Think of the equity as an OutOfTheMoney call
felix (12:27:34 PM): OK, with you so far
felix (12:27:50 PM): now why would bondholders, specifically, want to buy such a thing?
neubert (12:28:04 PM): Implied Volatility has more influence on the price of out of the money
call options that the price of the asset
call options that the price of the asset
neubert (12:28:46 PM): two reasons: 1. deal falling apart increases uncertainty with means higher
option value of equity. 2. voting for merger at $2.00.
option value of equity. 2. voting for merger at $2.00.
felix (12:29:51 PM): reason 1 I understand, reason 2 not so much
felix (12:30:04 PM): if you're voting for the merger at 2, why buy at 7?
neubert (12:30:23 PM): if equity holders try to stop sale (remember this is not a liquidation, it's a sale),
it will hurt the value of their debt
it will hurt the value of their debt
neubert (12:30:44 PM): Because you don't own shares right now. You need to buy them so you can
vote them.
vote them.
felix (12:30:49 PM): aha, so you're buying up the debt so that you can vote for the merger and make
it happen. got it.
it happen. got it.
neubert (12:30:53 PM): yep.
felix (12:30:54 PM): thanks!
felix (12:31:00 PM): do you want me to credit you with all this insight?
neubert (12:31:01 PM): We should post this chat.
neubert (12:31:05 PM): yes please.
felix (12:31:10 PM): will do
neubert (12:31:12 PM): I'd be happy with a link
neubert (12:31:17 PM): well credit is nice too.
felix (12:31:19 PM): no probs
felix (12:31:22 PM): you get both
felix (12:31:41 PM): and I'll even buy you one of those dinners you lost on your long BSC trade
neubert (12:31:54 PM): My disclosure of what I own is on my website too.
neubert (12:32:10 PM): Made it back today on Leh and pref shares.
neubert (12:32:17 PM): well most of it.
felix (12:32:29 PM): rather you than me, I guess traders love this kind of vol