Buying Puts After Getting Stopped Out of a Short Position

by: David Pinsen

Getting stopped out of a short position

Last November, I shorted St. Joe Co. (NYSE:JOE) at $17.99 as part of a market neutral trade going long another real estate-related stock, Getty Realty Corp. (NYSE:GTY). I had set a 33% trailing stop on both sides of that market neutral trade, and got stopped out of St. Joe Co. at $23.79 in early January, for a 32.2% loss on the short side of that market neutral trade (I then sold Getty Realty Corp., which was flat, so the total loss on the trade was 16.1%).

Buying puts on the stock afterwards

Since I was still bearish on St. Joe Co., I decided to buy puts on it a couple of days after getting stopped out of it. As I noted on the Short Screen message boards at the time, I bought the $25 strike Jan 12 puts on St. Joe Co. at $4.30. In that post, I mentioned why I remained bearish on St. Joe Co.,

Einhorn's fundamental short thesis here still seems intact: if you value JOE's real estate using the average sale price of it over the last ten years (which includes the sales during the boom years), the company is worth $10 or less per share. And every year, the company sells off more land to cover its overhead.

Berkowitz has said he'd buy the whole company if he could. Now that JOE has lifted his ownership cap, he can, but I don't think he will. After Berkowitz gets his fill of JOE, what catalyst is there for JOE?

A speculative options bet

When buying puts on St. Joe Co., I followed these guidelines:

  • Start small, since options often expire worthless (I employed about a third as much cash buying puts on St. Joe Co. as I had committed to shorting it previously).
  • Avoid out-of-the-money-options (the $25 strike puts were in the money when I bought them).
  • Avoid nearby expiration dates, to avoid theta burn and give positions more time to work out (the puts I bought had expirations a year out).
  • Buy options at a discount to model estimates of their fair market value (the puts were selling at a discount to the Black-Scholes estimate of their then fair market value at the time).

I've used those guidelines in making speculative options buys (both bullish and bearish) other companies this year as well, including Northern Dynasty Minerals, Ltd. (NYSEMKT:NAK), Motricity, Inc. (MOTR), Neutral Tandem Inc. (NASDAQ:TNDM); and calls on Honda Motor Co Ltd. (NYSE:HMC), Hitachi, Ltd. (HIT), and Coherent, Inc. (NASDAQ:COHR). I noted these purchases (and sales, in the case of the three of those positions I've sold so far) at the time on the Short Screen message boards.

Hedging vs. Betting

If I had been hedging, I would have entered the symbol of the stock or ETF I was looking to hedge in the "symbol" field of Portfolio Armor (available in Seeking Alpha's Investing Tools Store and as an Apple iOS app), entered the number of shares in the "shares owned" field, and then entered the maximum decline I was willing to risk in the "threshold" field. Then Portfolio Armor would have used its algorithm to scan for the optimal puts to give me that level of protection at the lowest cost.

On rare occasions (I’ve seen it happen once, so far) the optimal puts Portfolio Armor presents might be in-the-money; in most cases however they will be out-of-the-money. Since I’m making a directional bet in the cases below, though, and not hedging, I bought slightly in-the-money options. This makes sense for directional bets (when you are willing to pay more to reduce the odds against your bet) but would be sub-optimal in most cases for hedging (when you want to get a certain level of protection at the lowest possible cost).

Imperfect timing

After I bought puts on St. Joe Co., the stock continued to rise, peaking at close to $30 in January.

(Click to enlarge)

Since the puts weren't set to expire until January of 2012 though, there was time for the trade to work out. Those puts closed at $5.38 Monday, but I am still holding them as I'm still bearish on St. Joe. Co.

A missed opportunity

Although I bought puts on St. Joe Co. after getting stopped out of it, I missed a similar opportunity to buy puts on another stock, Toreador Resources Corporation (TRGL) more recently. I described that missed opportunity in a post on my blog last week.

Disclosure: I am long puts on JOE, NAK, and TNDM, and long calls on COHR.