I was just wondering about this and thinking if the market gets OK again and the economy is going OK and the DOW is 12,000, etc., will (and/or in your opinion - should) companies consider buying Puts on the overall market and/or competitors/other businesses in the same industry? If you think about it now, wouldn't MGM look smart if they were loaded on LVS, WYNN, IGT, etc. puts? How would F look if they had GM puts - WFC if they had C/BAC/JPM/etc, etc. puts? What if DSX had bought tons of DRYS puts when DRYS hit $120? I don't know if there is enough volume in some cases - in other words, for example could WFC have bought enough puts to make an actual difference right now, considering the potential losses in their portfolios? Businesses exist to turn a profit and they usually do it in one industry such as finance, autos, aerospace, or whatever, but there is nothing wrong with making money elsewhere, right? Understand, I am not in any circumstance saying businesses should consider active trading - this would be hedgeing downside economic/stock market turns only. In other words, in the future if MGM is $100 and LVS is $100 and eveything seems OK, MGM would still buy LVS puts IN CASE of events such as the last 6-12 months, etc. As far as the money they would lose during times the market stayed up, I am suggesting that maybe they would consider spending lets just say 5% of profits after tax, etc. on these puts. Even that would be a nice amount to have right now I'm sure as many of those puts would have gone up 10-50 fold depending on the exact situation. Let me put it another way and ask you guys another item - suppose you currently owned a small coffee shop that was like a Starbux, but was your own - things have slowed quite a bit and you barely get through the next year - but 2-3 years later, things are great. You look up SBUX and see it has recovered to $20/share. At that point, would you consider buying SBUX puts as a hedge against your business, using some excess profits you are now making, even if you don't see it going down? Could something like this become more common in the future as companies that realize there are legitimate risks in their business hedge by buying puts in similar companies and/or the overall market? JJacksET4
shareholders would be better served by spending that 5% on dividends than on a wasting asset outside the core business of the company
Do you really think so? I mean people have lost huge sums of money with wimpy dividends in the last year holding stock like WFC for example. If WFC had instead put some money into puts on C, BAC, JPM, etc and SPY, it's quite possible they would be doing very, very good right now and the stock might be at a decent level instead of $8 or whatever. I think getting 4% yields while losing 80% of ones investment isn't really the way to go anyways. If I buy a stock, personally I would rather have it appreciate in value due to good earnings then to have it drop and drop and drop and get a few cents for a dividend. BTW - just to be clear, I would assume the options to be longer term (they would still be wasting of course, but not like expiration in 1-3 months) Anyways, what do companies do with the 95% of earnings they don't return to shareholders (if they spend 5% paying dividends?). Often, they use it to expand, which may or may not be good (look at DRYS, MGM, etc. for examples of expansion problems!). If they earn $100 million one qtr - pay $5 million in dividends and then use $95 million as a down payment for a $900 million project, they build a bunch of debt and potentially get in big trouble later if the economy or their industry slows - if they would simply put $5 million into put options in their industry and the market, they would have somewhat of a hedge against all heck breaking out like what has happened. Let me add one more item - I think that corporate leaders, etc. have shown us recently that they are often complete and total idiots period no matter how smart they might seem in an interview or something and doing things the way they have always been done just doesn't work when decade old companies can be brought to their knees in a very short time with bad management. Anyways, thanks for your opinion. JJacksET4
Yes. Shareholders are able to sell at will and can use those same dividends to buy puts individually. More minds making the decisions is better, IMO -- it makes the market.
Yes, shareholders are able to do what they want with dividends, but we can bet most either just keep the money or reinvest in the company. I am not saying the company would have to get rid of dividends either - they could pay 5% and still spend 5% on puts for example. The way business has been done has clearly put once proud companies on the brink of disaster and elimination - I don't see what's so great about keeping the status quo. Let's put it this way - if you had most of your personal money in real estate investments, you could hedge that with puts on homebuilders and/or REITS and other RE companies. Otherwise, if real estate falls, you may find yourself in a mess, especially if you used leverage to buy up real estate. So, why shouldn't a company consider the same thing that an individual would consider? Companies end up getting so deep into one area that if that area goes bad, they are in big trouble - why not hedge their bets somewhat, maybe using options, maybe they have other ways (again though, management of some companies has proven themselves completely incapable of doing this). Heck, if a company like WFC had bought puts in C, BAC, JPM, etc., it's possible instead of cutting their dividend 85% like they did recently, they could actually be raising it, therefore giving their investors more money for them to decide what to do with. JJacksET4
Why do corporately what the shareholders can do individually? This is particularly poignant when the individual shareholders have little control over corporate actions and the actions are outside the core business of the corporation. Is it not true that investing capital in the business *is* a put on the competition if it is well executed? Share price as a focus of corporate executives is a model I would prefer to walk away from.
In a perfect world, companies could and should do whatever they can to maximize profit. So it would be a good idea for them to "buy Puts on the overall market and/or competitors/other businesses in the same industry." Yes, in the current environment they would have looked smart had they done this. However, there are several problems with this. Companies tend to focus on maximizing their own results and are not in the business of option trading, particularly those of the competition. That's the job of analysts and financial desks and even they can't get it right. How many brokerage firms have you heard of that are flying high now because they recommended shorting stocks and/or the market 18 months ago? Have you ever received a cold call from a broker suggesting shorting a position? If so, more than a fraction of those calling? But I digress... In most years, buying options is a losing proposition because w/o an edge, time decay kills you. The cost of hedging could be 5-15% a year, depending on the strike chosen and could be even higher on high IV stocks. From the hindsight position of today, after a 40% down market, it would appear Einsteinian to have done this pre Black Swan. But in most years, it wouldn't. For example, take Citigroup. It has been in a free fall for 18 months. But prior to that, it traded in an 8-9 point box for 4 years. During that period, most of the hedging money would have been lost. Pick any figure that you want. Cite any circumstances that you like. Even the best market timer would have had a tough time with that range. Did hedge funds get it right? Yes, some. But I doubt that they're under the same constraints as publicly traded companies. I don't know much about corporate rules but I surmise that even if hedging the competition via option trading is allowed, 5-15% yearly losses would not have sat well with shareholders. Going back to your lead in sentence (paraphrased)... If the market gets OK again, 12,000 or so, would it be a good idea for companies to buy puts on the market or the competition? No. It's a good idea to buy puts when the plethora of daily economic reports released is bad and continues to be bad, particularly the market. If the market is OK, what's the need for puts?
Spin, thanks for the reply. Of course, in retrospect, when the market was OK, there was a good use for puts - with the dow at 14,000, or even when it went to say 10,000, they could have and would have worked. My point again would not be that they need to be heavily involved in options trading and trying to "get it right", but that they would automatically "hedge" their company with puts. They would not read the market news and not try to time the puts. Also, again this would be started when times were good (a bit late now lol!) and would only use a small percent of profits (that there is a good chance the company will screw up anyways). Airlines often hedge oil costs of course, becuase they know if oil jumps from say $40 to $200 and they aren't hedge or prepared they could very well go under, even if airlines that are hedged are OK. Also, many companies (almost all major international ones as far as I know) hedge foreign currency just in case their business is OK, sales are fine, and then all of the sudden they get stuck with their money in a currency that plunges. Regarding the other posters comments that people can buy puts themselves, that is also true of currency hedging, but businesses still do it. An investor in airline stocks could buy an oil hedge, but the airlines still do it themselves as well for obvious reasons. I will assume that there is some sort of "insurance" cost to both hedging of oil and hedging of currency. I don't know how expensive the costs themselves are - I assume they are considered "the price of doing business" and considered a must for many corporations. I would view hedging against industry/overall market collapse as basically the same thing - not usually going to work or be needed, but boy wouldn't some homebuilder love to be long BZH and HOV puts right now! JJacksET4
Jjacks, Of course there's an insurance cost to hedging. Nothing is for free. Hedging is no exact science and it often sounds much better on paper than it is in reality. If you have ever tried to hedge long stock with long puts or collars when the stock was on the way down, you probably found out the hard way that it's a losing proposition. You stem the losses and dull the pain but it's just impossible to break even unless you overwrite, buy extra puts or the underlying reverses at some point in time. It's a lot of IFs. Airlines hedge jet fuel because it's the largest variable in their cost of doing business. But don't think for a moment that it's cost effective or that they have it down to a science. At its best, hedge money is throwaway money that locks in a price when the underlying is rising. At its worst, it's throwaway money PLUS it locks in higher prices after prices drop. Imagine how good it feels for them now if they have jet fuel locked in from when oil was $100 to $140 per barrel. Hedging is no utopian strategy. If you go back to last year quarterly earnings releases, you'll see massive red inks for most of the airlines which were attributed to the rising cost of oil. I wonder if the same occurred (or will occur) now that oil has tanked and higher prices were locked in. And FWIW, comparing hedging the costs of your cost of raw material with that of hedging by buying puts on another company in the same industry is apples and oranges.
That's where I don't completely agree. Even if times were good in the airline industry and say oil was at $40, every airline knows they might quickly go under if oil spiked to $400/barrel - they hedge that risk knowing it is costing them some money because they can't take the risk of literally wiping out years of growth because of a large oil spike. They aren't trying to make money on a huge oil spike - just trying to keep their business going. The key point is that oil prices are something each airline has 0 control over. Some people might look at oil now and wonder why airlines (lets say a new startup airline) would even hedge at this point - it seems fairly stable right now and almost no one is predicting a big spike in oil anytime soon, but you never know. In a way, same thing here - Homebuilders or Financials or Industrial companies can't control if an economy spikes downward out of control (similar to oil spiking upwards), so they could then hedge that with long puts on the market/competitors. Again, they know they can't control the economy - they can't control house sales for example, they can't control what the idiots in Washington might do, so they hedge. Using one of your earlier examples, lets assume during good years from say mid 1980s - 2005, Wells Fargo had always bought baskets of puts in C, JPM, BAC, etc. If their earnings some qtr had been $2.00, maybe they would have put $.05-$.10 share into these puts. Year after year, they would have lost on these, quite possibly 100% of the investment, but so what? They still would have had good profits, etc. Now, when the black swan event hits as it has, the company would avoid being on the brink because of the hedge. Understand, I'm not suggesting a company do this just to help shareholders, but to keep the company itself together through tough times. Of course a person who bought Well Fargo could have bought puts, but that wouldn't stop Wells Fargo from going under if they do bad enough. If you buy WFC and then buy puts to hedge your bet and then WFC goes under, that doesn't do the employees of WFC any good. I think that businesses are used to doing things in certain ways and over and over again formerly strong companies have failed big time (like AIG for example) because of unwillingness to change. They keep hiring business majors from Harvard as CEOs who do nothing but run them into the ground. Some of these companies would have been better off picking someone at random at a hockey game for their CEO - at least they couldn't have done any worse at least. I am amazed at the sheer stupidity of some of these companies - for example, recently a guy at work complained that Bank of America (BAC) charged him something like $10 for a fee for not having enough $ in his account or some little thing like that - anyways my point is they are that worried about getting their stupid $10, but they are OK with risking losing billions in toxic assets. I guess it upsets me to see a company that has been built over decades and in many cases was built by slow hard work as the company expanded and increased sales, etc. be brought down in 1 year either due to idiots at the top (and often not the ones who first brought the business it's profits) and/or due to a bad 1 or 2 year economic cycle. JJacksET4