ZAY Blog

Today was obviously an interesting day to see on GM and F and the not-listed Chrysler.

The news started to unfold at 9am, when President Bush announced the bailout plan for the Big Three (Big Two rather, since Ford is not asking for money), and the market reacted extremely positive at pre-market, when share price went up as high as 4.80 at one point of time.

Then market opened and within minutes, the share price fell back like free fall before coming back to 4.20 and stayed there for pretty much the rest of the day, and shot up to 4.47 right before the end of the day.

The day was particularly interesting as today is the expire date of all stock options expiring in December, and the market is definitely more volatile than usual despite the fact that it was trading at positive territory for the whole day.

First, my condolence to those owner of the put options, or those who wrote calls. The 3- and 4-dollar strike puts were virtually worthless, if the announcement were made a couple of days ago, there was still a chance of profiting from those puts, but unfortunately Bush just happened to announce it on the exercise day.

What surprised me, in this case, is all those shorters? Don’t they need to cover their positions ASAP? And why the stock is not shooting up as the short interests was almost 50% of the market cap?

Look at Citigroup, their shares were traded at 4 region, but went up to as high as 8.5 after the bailout. Why not GM and F?

My only guess is that the shorters have either shorted early enough to get a really good price, or they simply do not want to realize the loss and hope the price would bounce back a little or hold the short position till March and see if GM and Ford could turn in a reasonable rescue plan to restructure themselves.

However, today’s trading was by no means a good indicator of the perception of investors, since lots of options were exercised right before the market was closed (look at the last five minutes), the real reaction from the market to the bailout package would be in on Monday, when the regular trading resumes.

By then, hopefully the market will react more rationally to the news.

For the past two days, we’ve witnessed one of what I would personally considered as the most hilarious jokes of the year unfolded on Wall Street.

Quick quiz to those of you who are reading this:

1. If a company that has not lost a single cent ever since it went public in 1999, and was labelled the most profitable firm in Wall Street, has reported a quarterly loss, how should the market react?

2. If the average of the analysts’ estimate of the loss is $3.73 per share, and the company ended up lost $4.97 per share, how should the market react (based on either the Arbitrage Price Theory that I am sure every single finance student would know, or simply your guts feeling?)

I guess the most common answer would be the decline in share price.

And that happened to Goldman Sachs yesterday.

And GS rallied 15% yesterday.

It was interesting to see how the helpless financial news reporters say about this. The editors in Bloomberg, after scratching their heads for hours, came up with the excuse that the performance was better than the most pessimistic estimate from an analyst in UBS AG, who was predicting $5.50 per share loss (I bet all those shorters want to beat the hell out of that guy now). (http://www.bloomberg.com/apps/news?pid=20670001&refer=&sid=a6ku8xZK62X0) New York Times, being more political, simply said that it was “in line” with analysts’ estimates (OK, perhaps my English is really bad, but do English-speaking community generally consider miss by 33% from average as “in-line”?)

And the story did not end here.

This morning, Morgan Stanley reported its quarterly loss.

And this time, the average from analysts was 34 cents per share loss, with no estimate more than $1.15, according to Bloomberg.(http://www.bloomberg.com/apps/news?pid=conewsstory&refer=conews&tkr=MS%3AUS&sid=aKpeqFFx_giU)

The results was $2.24 per share loss.

Interesting enough, the share of MS rallied as much as 9.14% at one point of time before closing at 2.3% rise.

Now the most interesting part came, as both Bloomberg and New York Times found themselves in a awkward position that they could no longer explain the reason for such spike.

And their strategy was simple: based on facts. They simply reported the loss with no analysis/explanations.

In front of me is a copy of the shareholder’s prospectus on the Wachovia and Wells Fargo merger.

Put all the excitement aside (since this is the first time I am voting as a shareholder for a legal entity, although practically I do not hold any stock of Wachovia Corp as this point although I held an insignificant portion of Wachovia Corp common shares as of the recording date), I can not help to wondering whether there is any arbitrage opportunity arises here.

On the prospectus, it was stated that the merger was publicly announced on the 3 October, 2008 and the criteria of the merger is that each of the Wachovia common stock will be converted into 0.1991 of a share of Wells Fargo common stock. Using the law of one price, or the no-arbitrage principle, one should expect the common shares of Wachovia to be traded at 0.1991 times of the Wells Fargo stock. However, a simple Excel spreadsheet would reveal that is not the case.

The following table summarized the daily closing price of Wachovia Corp. (NYSE: WB) relative to the daily closing price of Wells Fargo (NYSE: WFC) from 2 October, 2008 to 12 December, 2008:

Average: 0.18468

St Dev: 0.018232

Count: 52

>0.1991:1

=0.1991:0

<0.1991:51

In the 52 trading days of data available, there is only one day that the share price of Wachovia Corp traded above 0.1991 times of that of Wells Fargo, and the average is slightly below 0.1991, at around 0.1846.

In the textbook, we learnt that in this case, the shares of Wells Fargo is overvalued and the shares of Wachovia Corp is undervalued and we should go short on WFC and long on WB.

However, why such “arbitrage” opportunity has existed for so long if, in theory, the market is efficient enough (the market in reality is a combination of semi-strong efficient and weakly efficient) to balance the demand and supply curve?

In my opinion, there are 2 major issues here
1. The uncertainty of merger. Although almost all major shareholders of Wachovia Corp have mostly accepted the fate of the bank, there are still shareholders who are contending for the merger, claiming that the merger has significantly undervalued the firm. It is very unlikely, but still possible, that such lawsuits will cause the merger to fail.

2. The volatility in the stock market: Although the shareholder’s meeting is going to take place on December 23, 2008, the merger is not expected to be completed  on that day. As a result, there may still be volatility in the share prices of both WFC and WB, which could affect the implied values of the shares.

Note that the market was able to quickly absorb the information and the ratio was relatively stable after the initial fluctuation, indicating the market is still fairly efficient despite that there was significant arbitrage opportunity initially even after the announcement was made to public.

However, it was also noted that out of those 52 days, in 44 days both shares went up and down together, hence it is safe to say that the market has indeed absorbed the information of the merger and is currently considering the two corporations as a pair rather than two unrelated stocks. When comparing to S&P 500 index (which is the proxy for the market portfolio), WB was traded with the movement of the market in only 27 out of the 52 days, indicating that is quite independent of the market movement.

Newsflash: The bailout has officially died in the senate as of 11:03pm, as it could not find sufficient number of votes from the Republicans to pass the legislation. Oil have down more than 2 dollars in the past hour and US Stock Futures have gone down for more than 3% tonight.

There will be another dreadful Friday in Wall Street tomorrow, will there be any chance for SDS to hit 130 again?

By the way, it is already impossible to short GM stocks from my broker, and I suspect it should be the same for everyone else as well.

I don’t feel like looking at the market tomorrow, to be honest…

Here is an interesting snapshot for SDS for the past 12 months of the year:

The closing price for SDS is way above the 200-day MA, hence indicating a strong buy signal. 

By adding in the volume factor, more interesting things happened, the interest of SDS is at its peak at the end of November, when it was at all time high of 133.20, which is completely understandable. However, the volume then went down and up and down, which matches the price pattern for SDS since the all time low of the stock market. As SDS is reaching a trading volume that is comparable to its lowest price recently (at the beginning of November), one could not stop wondering, is it going to be another opportunity for SDS to go up again?

The graph is equally interesting for momentum traders, with the momentum graph displayed at the bottom of the 3 graphs. The momentum is clearly indicating an upward trend, hence it should be a good pick for the momentum traders as well.

However, the reality seems to tell us that we are having a bull market, hence SDS, as a “short” stock, is coming down.

The fundamentals in the market is still weak, needless to say, but there seems to be an upbeat mood ever since Obama won the election. Besides the fact that the Christmas-effect is kicking in, we have a market that is eagerly waiting for the outcome of the bailout package for the Big Three automakers, which could come at any time. All these could possibly contribute to the unusual upward trend in the overall market and therefore creating a false picture that the market is recovering.

Just thought this is an interesting example for those who are studying for the Investment course in UW, as the final exam is coming this Friday.