raventrader

Whose Freddie Investment Thesis Is Right?

Cute! Of course there's no rhyme or reason to the .5 prob, and it isn't a discrete situation anyway. Stocks are generally considered to follow a lognormal distribution, so if you want to crank an expectation value that's the way to go about it. Even then, there's some question about what you use for your mean and standard deviation.

You do have a good point though- the upside (long FRE and FNM) has a greater potential for returns in the best-case scenario! And the upside has defined risk. If I buy 100 shares of FRE, the worst that can happen is that it goes to zero. The most I can lose is $324 (if I bought it right now). Not bad- I could handle the loss, and the profit could be significant.

Now, if I take the down bet, I could lose a lot- let's say the stock triples after I short it. That means I'm out $648. If it does increase by a factor of 7.5, I'd be out over 2k!

Shorting a low-price, beaten-down stock like that never seems wise to me. For one thing, as soon as that stock starts to jump, people will cover their short positions, and that means prices will skyrocket even faster than they fell.

Besides, when you're short a stock, you get charged interest.

There's no simple way to mathematically model this situation, but I'd say common sense says go long or stay out.