Skip to main content

Why hedging is so difficult

I am often asked why I say that hedging your position is so difficult (Ok not that often -- still) one thing for sure it can be a challenge to understand.  This week I was handed the perfect example; Peabody Energy -- which has a large HY debt exposure and is a publicly listed company with a sizable float (e.g. large percentage of shares widely owned).  Peabody is a coal company -- not exactly the market darling, in fact, its a bit of a dog.  At this current burn rate its tangible net worth will be negative within 6 months -- I'm speaking trend her -- it has $900 MM in TNW and is losing about $800 MM per quarter.  In 2014 it has more than $2.5 billion in TNW...

The debt market had been pricing Peabody in the dumpster, but there was still a bit of play, and so the obvious trade was go long the debt  and go short the equity.  In other words the price of equity will drop much more than the price of the debt (this relates to the fact that debt is more senior than equity and if there are failure the equity will be killed -- so will the debt, but far less).  So the trade here is buy the debt at 25 (25 for a instrument that is paying interest against 100...) and short the stock -- as you sell the stock (and borrow the stock) its price over time will fall, and you will make more money.  This is a close to cannot lose trade -- except when it doesn't work. 

It appears that the debt and equity markets have a very different perception about Peabody Energy's future [NYSE:BTU].  The debt is now priced at 3 -- giving investors a coupon of 269%, and the equity is up 40% at 4.51 (Tuesday).  

The hedge fund that put this position (about a month ago) is gone!  He has lost on the entire trade on the upside (the debt; 25 to 3) and on the equity from 2.21 to 4.51.  Just goes to show -- you know nothing!



Comments

Popular posts from this blog

Ok so I lied...a little (revised)

When we began looking at farming in 2013/14 as something we both wanted to do as a "second career" we invested time and money to understand what sector of farming was profitable.  A few things emerged, First, high-quality, source-proven, organic farm products consistently have much higher profit margins.  Secondly, transformation accounted for nearly 80% of total profits, and production and distribution accounted for 20% of profits: Farmers and retailers have low profit margins and the middle bits make all the money. A profitable farm operation needs to be involved in the transformation of its produce.  The low-hanging fruits: cheese and butter.  Milk, generates a profit margin of 5% to 8%, depending on milk quality.  Transformed into cheese and butter, and the profit margin rises to 40% (Taking into account all costs).  Second:  20% of a steer carcass is ground beef quality.  The price is low, because (a) a high percentage of the carcass, and (b) ground beef requires process

21st century milk parlour

When we first looked at building our farm in 2018, we made a few money-saving decisions, the most important is that we purchased our milk herd from a retiring farmer and we also purchased his milking parlour equipment.  It was the right decision at the time.  The equipment dates from around 2004/05 and was perfectly serviceable, our installers replaced some tubing but otherwise, the milking parlour was in good shape.  It is a mature technology. Now, we are building a brand new milk parlour because our milking cows are moving from the old farm to the new farm.  So we are looking at brand new equipment this time because, after 20 years of daily service, the old cattle parlour's systems need to be replaced.  Fear not it will not be destroyed instead good chunks will end up on Facebook's marketplace and be sold to other farmers for spare parts or expansion of their current systems. All our cattle are chipped, nothing unusual there, we have sensors throughout the farm, and our milki

So we sold surplus electricity one time last summer...(Update)

I guess that we will be buying an additional tank for our methane after all.   Over the past few months, we've had several electricity utilities/distributors which operate in our region come to the farm to "inspect our power plant facilities, to ensure they conform to their requirements".  This is entirely my fault.  Last summer we were accumulating too much methane for our tankage capacity, and so instead of selling the excess gas, that would have cost us some money, we (and I mean me) decided to produce excess electricity and sell it to the grid.  Because of all the rules and regulations, we had to specify our overall capacity and timing for the sale of electricity (our capacity is almost 200 Kw) which is a lot but more importantly, it's available 24/7, because it's gas powered.  It should be noted that the two generators are large because we burn methane and smaller generators are difficult to adapt to burn unconventional gas, plus they are advanced and can &qu