flytiger
Registered: May 2005
Posts: 5829 |
08-11-08 01:11 PM
Hedge funds, concerned about losing their money, weren't convinced. Eagle Asset Management Inc. moved to other prime brokers, according to Managing Director Todd McCallister. Investors who had credit default swap contracts with Bear Stearns turned to Goldman Sachs Group Inc. and other Wall Street firms, asking them to buy the contracts.
Bankruptcy Put
On Wednesday, March 12, Schwartz appeared on CNBC, live from Florida, saying the company had ample resources to weather the credit crunch. While for the moment, at least, that assuaged concerns in the market, the capital flight began again the next day. Many of Bear Stearns's traditional creditors reduced or halted their lending to the 85-year-old company founded by Joseph Bear and Robert Stearns.
By the end of the day, Bear Stearns's cash was almost depleted and its stock closed at $57. As Schwartz realized the company couldn't function on Friday without access to overnight borrowing, he called government officials, regulators and JPMorgan CEO Jamie Dimon.
After discussions late into Thursday night, the Fed agreed to provide cash through JPMorgan, the second-biggest U.S. bank by market value, because Bear Stearns didn't have direct access to the Fed as a lender of last resort.
Then, on March 14, the CBOE listed a series of put options with less than five days to expiration. The lowest strike price, $5, was more than 90 percent out-of-the-money in what options traders refer to as a ``bankruptcy put.'' Bear Stearns slumped 47 percent that day to $30 in NYSE trading.
`One Tick'
The out-of-the-money Bear Stearns puts point to a raid, said Baker, who's now a securities lawyer whose clients include companies that have filed complaints over naked short selling.
The $25 Bear Stearns puts, and others obtained March 14 involving the right to purchase 630,000 shares at a strike price of $5 by March 22, were ``bizarre,'' according to Haugh, the PTI partner who spent 18 years as a CBOE options-market maker.
John Olagues, who started trading options 30 years ago, said he has never experienced anything like it. Olagues, who runs a New Orleans consulting company called Truth in Options, also manages more than $1 million for a client who had a stake in Bear Stearns, which plummeted 94 percent in value on March 17. The drop prompted Olagues to start pouring over options trading records and call officials at the CBOE.
``In just one tick, the company's share price lost nearly all its value, a steeper drop than Enron's right before its de-listing in 2001,'' said 63-year-old Olagues, referring to the bankruptcy of Houston-based energy trading company Enron Corp. ``I've never seen a stock perform like that in my life.''
Vertical Put
Olagues, who was an options market maker at the Pacific Exchange and then the CBOE from 1976 to 1984, said he knows all about so-called time decay, implied volatility, arbitrage and the complexities of options trading. The former all-conference pitcher at Tulane University, who started his own firm called Truth in Options in River Ridge, Louisiana, in 2003, said he has found options transactions that convince him Bear Stearns was the victim of insider trading.
``I would stake my reputation on that,'' he said.
Olagues said he was able to avoid losses for his client on Friday, March 14. His hedged position -- a so-called vertical put spread designed to absorb losses as great as 50 percent -- made money by the closing bell that day. The hedging failed the next trading day, March 17, when the stock opened at $3.17.
``Nobody prepares for the stock going from $57 to $3 in just two days,'' he said.
SEC Review
Schwartz told the U.S. Senate Banking Committee on April 3 that there are ``lots of reasons why people could have a financial motivation to induce panic'' and ``a lot of trading would point to that.''
Bear Stearns has forwarded options data to the Senate Banking Committee and the SEC, said a person close to the firm, who declined to be identified.
SEC Chairman Christopher Cox told Congress last month that the agency is probing whether illegal trading spurred the collapse of Bear Stearns and the 72 percent drop this year in Lehman Brothers Holdings Inc.'s market value. The inquiry focuses on investors suspected of seeking to profit by intentionally spreading false information about the companies.
The SEC subpoenaed Wall Street's largest firms and hedge funds for trading records and communications, including e-mails. The agency also enacted an emergency limit on so-called naked short sales in Freddie Mac, Fannie Mae and 17 brokerages as it prepares broader rules to thwart stock manipulation.
`Turbocharge' Effect
Naked shorting, which can be illegal, occurs when short sellers who intend to profit from a decline in securities prices fail to borrow stock by the settlement date. Traders can use that method to drive down prices by flooding the market with sell orders.
The strategy can ``turbocharge'' the effect of false rumors on a stock price, Cox said on a July 16 conference call with reporters. The SEC will consider new rules to prevent improper short selling, Cox told Congress on July 24. It also may force investors to disclose ``substantial'' bets on falling stocks, he said.
On Tuesday, March 11, when Federal Reserve Bank Chairman Ben Bernanke attended a luncheon with Wall Street executives at the New York Fed and the CBOE listed its $25 Bear Stearns put option, McCarty of Meridian red-flagged Bear Stearns in his ``MEP Noteworthy Option Activity'' memo.
Big Bets
What got McCarty's attention that day was the volume of put trading in strike prices of $35 and below. Investors bought 84,109 puts at strike prices that would require a calamitous drop to make money, he said.
``Somebody placed some big bets that day that paid off,'' McCarty said. ``The question is did they make it pay off?''
On March 14, when Schwartz sought emergency funding, Bear Stearns opened at $54.24 in NYSE trading. That day, the CBOE listed eight new put options that expired in five days with strike prices that ranged from $22.50 to $5. The lowest was 90.7 percent below the opening stock price.
Gail Osten, a spokeswoman for the CBOE, declined to say who placed the order for the options.
``Nobody in their right mind would buy that put unless you knew what was going down,'' said Ray Wollney, Olagues's partner at Truth in Options. On Friday, March 14, a total of 6,303 of the $5 Bear Stearns puts traded.
Paulson Calls
That night, Schwartz got a call from Treasury Secretary Henry Paulson making it clear that the Bear Stearns had until Sunday evening to find a buyer because the Fed planned to withdraw its financial backing. Paulson, who didn't want the government to appear to be bailing out a Wall Street firm, then brokered the sale to JPMorgan.
Schwartz and Bear Stearns Chairman James ``Jimmy'' Cayne convinced fellow board members by explaining that their only alternative was to accept the deal or face bankruptcy. The agreement was announced Sunday night.
Options bets that looked irrational on Friday proved brilliant on Monday, when the shares traded between $3 and $5. By Wollney's calculations, the traders who spent $35.8 million on the deep out-of-the-money puts reaped an estimated $274 million windfall from the plunge in Bear Stearns.
Peter Chepucavage, a former general counsel for compliance at Nomura Securities and onetime SEC lawyer, said the Bear Stearns bets were neither smart nor lucky.
`Riddled With Bullets'
``When you buy $5 strikes when the stock is trading over $50, you either have to be manipulating, or you have to have insider information,'' said Chepucavage, who's now with Washington-based Plexus Consulting.
John Welborn, a London School of Economics-educated economist who works at Haverford Group investment firm in Salt Lake City, has been analyzing data released by the SEC on Bear Stearns shares sold but not delivered to buyers within the required three-day limit.
From March 10 to March 14, SEC data show that the failed Bear Stearns trades jumped to 2.1 million from 19,424, Welborn said. The failed trades correlate with increases in the firm's put volume. The volume of Bear Stearns puts soared to 237,770 on March 11 from 32,081 on March 7. Put contracts doubled again to 445,635 on March 14.
``It looks to me like Bear Stearns got riddled with bullets,'' Welborn said.
The question is whether the trading was premeditated and designed to ruin Bear Stearns, Chepucavage said. If there is a link between these separate activities, only subpoena power will be able to establish it, he said.
``Track the rumors,'' Chepucavage said. ``Follow the puts.''
To contact the reporters on this story: Gary Matsumoto in New York at gmatsumoto@bloomberg.net.
Last Updated: August 10, 2008 19:01 EDT
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