Saturday, September 20, 2008

Things you can’t do with the short-selling rule

This is a little winge – but it also exposes another unintended consequence.

These days financial institutions are much more concerned about their debt spreads than their stock price (though the two are correlated). They would however generally like people who short the stock and go long the distressed debt.

I desperately wanted to do so with WaMu today. WaMu common was trading at 4.25. The preferred was trading at under a quarter par.

I can’t see the common quadrupling from here. But I can see the preferred going back somewhere near par. [That would happen for instance if Citigroup purchased WaMu.]

So I so wanted to do the arb – short WaMu, long the preferred.

I was not allowed and that sucked.

Moreover as the common is liquid my shorting wouldn’t have changed the price much. The pref is illiquid and my going long would lower WaMu’s perceived cost of funds.

The rules (a) denied me a trade, and (b) made it incrementally harder for WaMu in this case.

Not the best outcome all round.

John Hempton


bryanwillis said...

There are possibly more important matters in the world happening even as I write,but I think I would be remiss if I didn't at least note that "winge" usually contains an "h", usually written immediately following the "w".

Anonymous said...

Why not just sell an in the money call? Or, if you want to be more perfectly hedged -- i.e. short WAMU common -- buy an atm put/sell an atm the call.

I much enjoy your observations and pithy commentary. Keep it up.

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