Who Is Doing What To Whom On Carl Icahn’s Netflix Trades?
If I were the sort of guy who could come in to a company, yell at them a bunch, and get them to sell themselves to someone else at a premium, I would:
do that often!, and
buy lots of call options on the stock before doing it.
Right? If I bought the call options for, I dunno, $23 an option, and they had a strike price of $36 per option, let’s say, and I bought 5 million of them, and the company eventually sold itself for like $80, then I’d be stumping up like $115 million initially and getting back $220 million for a profit of $105 million, or ~91% of my original investment, and that would be sweet. If instead I boringly bought shares at, say, $59 per share, and it eventually sold for $80, then I’d be putting down ~$295 million to get back ~$400mm for only a ~36% profit. More importantly if somehow I failed to convince this company to sell itself, or even worse if I failed to convince others to buy it, the stock might go lower – maybe really low. If the stock went to $20, I’d lose my entire $115mm option premium, but that’s better than losing $195mm if I’d gone and bought the stock.
In other words, putting a company into play increases its volatility. Options gain value with volatility. Buying an option and then making it more valuable through your own actions – going out and making volatility happen – is a good strategy. So good it’s basically magic.
So good it’s impossible! Because: what kind of idiot would sell you that option?
Let’s ask Carl Icahn. Today he announced a just-under-10% position in Netflix this afternoon. The stock closed up ~14% (after being up ~21% earlier) on the news. And as it happens, Icahn’s Netflix position was almost entirely in the form of call options, so he just made a bajillionty dollars on paper.
Here is what Icahn says about those arrangements:1
The Reporting Persons purchased, in the over the counter market, American-style call options referencing an aggregate of 4,291,066 Shares, which expire on September 4, 2014. The agreements provide for physical settlement (unless the Reporting Person opts for a cash settlement). These agreements do not give the Reporting Persons direct or indirect voting, investment or dispositive control over the Shares to which these agreements relate. These agreements are further described in Item 5(c).
The Reporting Persons have sold, in the over the counter market, European-style put options referencing an aggregate of 4,291,066 Shares, which expire on the earlier of September 4, 2014 or the date on which the corresponding American-style call option described above in this Item 6 is exercised. The agreements provide that they settle in cash. These agreements do not give the Reporting Persons direct or indirect voting, investment or dispositive control over the Shares to which these agreements relate.
The strike price of all of the call options is $36.05, and they were purchased for premiums ranging from $18.94 to $24.78. A plurality were bought for $23.13 on October 24, 2012, when the volume-weighted average price per share of NFLX was $59.18.2 The put strike and purchase prices were not disclosed.
Here are two simple warm-up questions:
What is the strike price of the puts?
How much did Icahn get paid for the puts?
Here are the answers:
The strikes are $36.05.
He got paid zero dollars for the puts.
The first is easy. If I sell Carl Icahn a call option on Netflix stock at $36.05, then I am short NFLX volatility to Carl Icahn: the call option’s value goes up as the stock gets more volatile. But, remember, he can make the stock more volatile. He just did. So: if I am not an idiot, I will not sell volatility to Carl Icahn. Therefore, I will never sell him a call option, unless I got a completely offsetting put option. If I sell Icahn a call struck at $36.05, and buy from him a put struck at $36.05, then by the magic of put-call parity I have just sold him the stock forward at $36.05. If the stock ends up at $100, he buys the stock at $36.05. If it ends up at $1, he buys it at $36.05.3 I don’t care what the stock’s price does, I don’t care what its volatility does, and I don’t care what Carl Icahn does. He’s buying the stock from me at $36.05, and since I am a dealer I have hedged by buying the stock already. At say $59.18. So as long as he pays me at least $23.13 for the two options combined, I am indifferent to what happens.
The second question is slightly harder. But take October 24, when Icahn paid $23.13 per share for $36.05-strike options on a stock worth $59.18. Bloomberg will tell you that that option is worth around $28.92, so he underpaid by $5.79 per share.4 Arithmetic, however, which is often more useful, will tell you that $59.18 (the price of the stock that day) minus $36.05 (the strike of the option) = $23.13, which is the minimum price that the dealer could charge for the call option assuming that no money changed hands on the put option. So Icahn paid the very minimum price he could have been charged for the call, meaning that the dealer who “bought” the put options from him almost certainly paid zero dollars for them.5
So like I said those were warm-ups; the real question is: why do this? Why not just buy stock? The answer that I started with – leverage! volatility! – is plainly nonsense: you can’t rely on any explanation that assumes a customer, even a savvy customer like Icahn, is systematically and predictably taking advantage of a derivatives dealer.6 Selling naked call options to a corporate raider is awesomely dumb – Icahn can ruin you with one press release! – so nobody would do it. All that Icahn’s done is buy the stock forward.
So why buy it forward? The answer is super boring, I think. It seems likely that Icahn works this way to avoid HSR filings: the antitrust laws require you to file forms, pay fees, alert the company, and maybe get public disclosure if you’re going to buy more than $68.2 million of Netflix stock. That sucks; it costs time and money and alerts the company when you’ve bought only $60ish million, rather than $300ish million, of their stock. If you want to buy cheap and profit from your press release, rather than buy expensively after the stock has already priced in your interest, avoiding HSR is economically important. And buying via options lets you do so.7 [Update: a reader points out that, if you multiply Icahn's 1.25mm physical shares by the $54.74 purchase price listed for the last of them, you get ~$68.4mm, or right up against the HSR threshold, further evidence that Icahn's tactics are driven by HSR. He also points out that Whitney Tilson takes the contrary "very bullish, leveraged bet" view.]
So there’s your boring answer: Icahn didn’t get long Netflix to take advantage of his dealer’s stupidity, but to take advantage of his dealer’s HSR exemption. Now, here are some extra-credit questions. Theoretically the put + call are delta one, so the dealer should hedge by buying 100% of the underlying stock, or ~4.3 million shares. So:
If you were doing this trade with Carl Icahn, would you initially “hedge” by buying, say, 110% of the underlying stock, and then sell down after he files his 13-D and announces his position?
Would overhedging like that constitute insider trading? Why or why not?
Did his dealer do that here?
If the dealer(s) had done that, and sold at today’s closing price, they made ~$4 million today, or ~$8 million total if they put on the trade at ~$59 a week ago.
Sentiment: Strong Sell
CARL FRAUD DERIVATIVE TRADE AND LOOT IN $100'S OF MILLIONS IN FEW WEEKS?HANG S.E..C CRIMINALS IN A PUBLIC SQUARE ASAP
by singhlion2001 . Jan 7, 2013 12:47 PM . Permalink
Carl icahn is hedge fund thug looting usa 99% working class pensions
that #$%$ does not serve usa .....just a fraud financial terrorists looting with scam derivative trades
why is that #$%$ silent now?
why is he not pumping his scam scamflix value?
Sentiment: Strong Sell
Sentiment: Strong Sell
In fact the dealer must have beaten VWAP by a few cents and/or charged him a fee elsewhere, because this trade – facilitating a ~10% stake by a corporate raider by buying 5mm shares of stock – is not going to be free. Also, if I were his accountant, or his dealer’s accountant, I might have issues with him underpaying for the call and getting paid zero for the put, instead of pricing each leg at fair value? But on the other hand if I were his securities lawyer I would have issues with him listing the full-price premium for the call, without listing the offsetting put premium, because it might make it look like he’d invested more in NFLX than he did? Discuss.
The dealer is buying the stock delta one to hedge, but the dealer is exempt from HSR because it has no control intent, is a dealer, etc. Also: buying via options does get you financing; you only have to post the net premium for the options plus maybe some formulaic margin on the puts you are short. Presumably the margining is better on the options than it would be on an equivalent explicit forward contract, which is why this is put + call rather than an explicit forward, though I don’t really know what the margin rules are here in part because we don’t know what the counterparty bank is and in part because I am pretty ignorant on margin rules.
Goldman Sachs Doesn’t Care If You Want To Know If Your Girlfriend Is Wear Black Panties Or White Panties And If She’s Going To Excuse Herself During Dinner To Take Them Off And Then Make You Wait Through Dessert To Take Them Out Of Her Bag And Stuff Them In Your Mouth
Sentiment: Strong Sell
Netflix has also been hit by a massive slowdown in the number of US subscribers after it raised its subscription fee, which came on top of higher postal rates in the US, where it still runs its legacy films-by-post business.
The timing of the slowdown could seriously stymie the company’s international growth, says Toby Syfret, at Enders Analysis.
“Netflix needs a very large wallet. Looking at the past couple of quarters, where there has been a big deceleration of growth, they could find themselves in a lot of trouble,” he says.
“Although the mood of the successive quarterly results releases remains strenuously upbeat, Netflix, we believe, is treading a thin and slippery tightrope.”
To add insult to injury, Net-flix insiders cashed in $90m of shares while they were at a record high, with Hastings collecting around $43m of the windfall. Investors, furious that he profited while their investments slumped, are now suing Hastings and other Netflix directors for “misleading” shareholders by “concealing negative trends” in the business.
“Rather than fully disclose the devastating cost increases which were then threatening Netflix’s entire business, defendants talked about its ability to grow,” they said in a lawsuit filed in California, which is still ongoing. Netflix declined to comment.
Hastings offers little comfort. “My lens on the world is different to most people’s. I like to invest in things that will give me a return in decades,” he says.
He will not be drawn on what his decision to sell Netflix stock says about the company’s future, but it is notable that he went against the grain this month by investing $1m in Facebook, where he is a member of the board.
The social network, whose initial public offering earlier this year ranks as the worst-performing technology float in history, saw its share price drop further this week after lock-ins, preventing employees from selling their shares, begin to expire. But Hastings thinks the company is considerably undervalued.
“I look at the role of social [networks] and it makes me very bullish,” he says.
He is similarly upbeat about Microsoft, where he is also a director. The computer giant founded by Bill Gates famously dominated in the early 1990s, but is widely seen as having lost its Midas touch to the likes of Apple and Google. However, Hastings claims the company is on the up again.
“Microsoft’s greatest days are ahead of it. If you look at how they have risen to the challenge with Windows 8 and Surface [its new tablet device], you are going to say, 'Wow, this is the Microsoft we used to know’. There is an incredible amount of innovation going on.”
His comments are likely to raise eyebrows among analysts and Apple acolytes. But although his predictions for Microsoft might feel like a bit of a stretch, it remains moot whether the same remarks could be made of Netflix.
Sentiment: Strong Sell