The adventures with put options



Midas was feeling a little bored on March 14. His money was mainly sitting in Treasury Inflation Proof Securities and muni bonds, gently losing value. With luck, he felt that cash would be relatively safe from the depredations of the Jimmie Caynes and Angelo Mozilos, of Bear Stearns and Countrywide notoriety, who think nothing of wiping out 80 per cent of their shareholders’ assets in a trading week or half a year. But there is no excitement in Tips and munis.

Midas had also been feeling rather grouchy for months, because he knew he should have bet against financial stocks such as Citigroup and Countrywide last August, when it was clear to him that they were in trouble and that the market was in denial about how deep the doo-doo was going to be. Since stocks and markets do go down occasionally, it seemed to Midas it was high time to learn how to profit from declines. Merely taking it on the chin in a long stock portfolio, or scuttling off to shelter in cash while the storm passed, had become unsatisfying.

Whenever Midas is going to make a bet to back his judgment, he talks it over with clever friends first. They invariably tell him that while he might be right he probably is not, and to stay calm and avoid driving fast cars. Now, since Midas can never prove his hunches, and feels that to override these respected people he really should have a water-tight case, he finds their cautions sobering. So he does nothing and later kicks himself.

Finally, on March 14, Midas threw caution to the winds. He decided to throw a small amount of money into put options on some firms in the financial sector. And he did not call his friends for permission. Then he got doubly lucky. For those of you, like Midas until recently, who are unfamiliar with the hairier end of the stock casino where put options reside, here is how they work. A put option is the right to sell a stock at a particular price before the option expires. It has value if the price of the stock concerned goes down enough before expiration. It becomes worthless otherwise.

So on Friday, March 14, Midas bought about $1,000 (Dh3,672) worth of April puts on each of Citigroup, JPMorgan, Bear Stearns and Moody’s. He won’t bore you now with detailed arguments for betting against those companies, but will just say there are plenty to go around. Try prospective dilution, trillion dollar positions in credit default swaps, a run on the bank and lost credibility of ratings, respectively.

While Midas thought he had bought a thousand dollars worth of puts on each stock, at the time he placed his orders his little dog Trixie was sitting on his lap and making it hard to reach the calculator. So Midas relied on mental arithmetic to calculate how many options to buy. Turned out he missed a decimal point on the Bear options – Midas is more of an arts man – and he had actually put $10,000 into those puts. An hour or so later, Midas re-calculated and realised he had sunk 10 times as much into the Bear puts as he had intended. Too late. They had already lost quite a bit of value, since, on March 14, trading in Bear featured frenetic ups and downs.
So Midas decided to play it like a man and hang in there, rather than cut his stake and accept an immediate loss. So here he was at Friday’s close, hoping Bear would drop from the $29, where it stood when he bought his puts, to below the $20 strike price of his puts. Actually, since the puts were expensive, at $5.40 apiece, he actually needed the stock to drop to $14.60 just to break even.

Imagine Midas’s disgust two days later, in the afternoon of Sunday, March 16, when the newswires were suggesting that Jamie Dimon of JPMorgan was going to buy Bear for $20 per share. It looked like one of Midas’s all-time greatest howlers – a $10,000 loss in a weekend. Mrs Midas was not informed, needless to say.
As you know, that $20 price report turned out to be erroneous, and Midas was transformed from goat to genius by the time Sunday’s dinner was over. Jamie’s price for Bear was officially announced at $2 per share. Mrs Midas, duly informed, at once complained that Midas should have put $100,000 on the bet and made some serious money. [Mrs Midas is good on many subjects, but Midas has never considered high finance to be one of them.]

Monday morning rolled around and the market opened, but Midas was disappointed to find that his put options were not now worth $18. The right to sell for $20 what Jamie will only pay $2 for should be worth $18, no? No. Some disgruntled Bear shareholders were not willing to sell for $2 and they and other speculators kept the share price up around $4 that Monday.

Midas decided not to be totally greedy, and to sell off half his puts, grudgingly, at $16 each, hanging on to the other half for the full $18 that was his due. As you know, it took another weekend for tragedy to strike, in the shape of Jamie’s gutless retreat, upping his Bear bid to $10.

You would think he’d have called Midas before running up the white flag. To cut a long story short, Midas got out of the rest of his Bear puts at $9.50. An accidental $10,000 investment – OK, call it a gamble – turned into $25,000 in about 10 days.

Those of Midas’s readers who love to spoil a good story will by now be demanding to know how the Citi, JPMorgan and Moody’s puts have fared.

Midas has to admit that these other three gambles are not looking great at the time of writing, but three weeks is a long time in this crazy financial market and anything could happen before the puts expire. Maybe China will sue Moody’s over all those AAA-rated bonds they bought that are now looking ragged around the edges. Who knows? Midas only needs Moody’s to fall to $29 to get his money back.

You critics are right that Midas can’t take credit for the mistake, which allowed him to make $15,000 on the Bear puts instead of $1,500, thereby covering the cost of his other $3,000 worth of puts even if they expire worthless. That was indeed dumb luck.

So is Midas chastened by these lessons that fortune has provided? Of course not. The thrill of winning a gamble like this one is not conducive to humility. With some of his Bear winnings, Midas dropped $5,000 into puts on Lehman, the other investment bank rumoured to be in trouble.

The market was unkind enough to stage a recovery soon after that, leading Midas to feel some remorse. So when Lehman stock dived again and permitted him to get out with a small profit, he cashed in half his chips.  Then he read a scathing review of Lehman’s balance sheet and low quality of earnings by Jesse Eisinger, one of the few financial journalists who does real analysis any more, and felt better about holding on to his remaining puts. At times over the past few days the puts have traded at well above the price he paid for them, but he is holding out for more.

Perhaps the latest news, that Lehman got taken for a few hundred million dollars by some fraud artists connected to Marubeni, will put a further dent in Lehman’s value. But perhaps not.

With the Federal Reserve playing fairy godmother to Wall Street these days, Ben Bernanke will probably make good those latest Lehman losses with another run of his printing press.

In case you are wondering. Midas does not feel the slightest twinge of guilt at potentially profiting from the demise or discomfort of great finance houses such as Bear and Lehman. Like it or not, these firms are driven by no sentiment other than greed, and we have that on the best authority. Midas recalls many years ago, as a business school student, asking the co-head of Goldman Sachs the rationale for a particularly absurd merger that his firm had put together.

The only thing shocking was the man’s candour. “Two words: abject greed,” he laughed. That merger had to be undone a few years afterwards, racking up additional fees for the investment advisers and costing shareholders a bundle. These outfits have always taken advantage of every opportunity to make a buck, regardless of the social cost. It is in their genes. So Midas keeps his sentimentality for Trixie the dog.

If you are attracted to the idea of making money in a falling market, by venturing into the options game, here are some lessons that Midas thinks he discerns from his recent escapades:

  - Only play the put game with stakes that you don’t mind losing, because you probably will lose the whole lot.

  - Do not place your orders with a dog on your lap, unless she will bring you luck.

  - Only play if you can get to your computer most of the trading day to check on the option’s value. These things bounce around in price so fast that you have to be able to sell when the move is favourable.

  - Use a discount broker and trade electronically, to keep the transaction costs from eating up any gains.

  - Get into the game early if you spot a down trend. The rewards for playing puts on the banks last summer must have been much higher than they are now, for two reasons. Bank stock prices had much further to fall back then and, with fewer people betting against them, the puts would have been cheaper. As one of my clever friends says, paying $5.40 for a six-week put on Bear was terribly expensive. He is right, but I’m 15 grand better off for not asking his opinion!

  - If it is economic, go for distant expiration dates. Even if you are right about a company being worth less than its current price, there is no telling how long it will take others to share your point of view and bid the stock down. This is another reason for jumping on your hunch early, because puts with distant expiration dates are naturally more expensive than puts with only a few days or weeks to go. If only a few people share your jaded perception of company’s prospects, because you are early, you may find the price of a one-year option acceptable.

  - Only tell your spouse if and when you have winnings to gloat over together. Your losses will hurt quite enough without your partner spelling out your folly.

Midas welcomes readers’ comments at, but cannot take responsibility for his own investment decisions, let alone anyone else’s.

The numbers


$25,000: The returns the author received by investing $10,000 in Bear Stearns put options in just 10 days 


$10: The final price offered by Jamie Dimon of JPMorgan per Bear Stearns share. Dimon earlier offered $2 per share


$10,000: The amount the author might have lost within a weekend had the erroneous newswire report that JPMorgan was going to buy Bear for $20 per share been correct