Friday, October 07, 2005

Arbitrage Without a Long/Short is Stupid

Remember when I said that you could make some money on SPCHA because it's trading at a 16.5% discount relative to SPCHB? Unless you have a way of shorting SPCHB and longing SPCHA... forget it! That's the lesson I learned on $1000 lost! :D

I bought some shares in SPCHA the other day, thinking that there is absolutely no reason for the stock to go down because SPCHB is trading at a price that can't possibly go lower--what's my reasoning? The stock is illiquid enough so that thoughout its history, it has hovered around it's 11.00 value without much trading going on. A "stock split" shouldn't change the value of the B class too much right? WRONG!

For the sake of clarity, let me reiterate what happend:

- Class B shareholders have 1 vote for every share held
- And for every share held, they got a new Class A share which have 1/20th of a vote, but garners 110% of cash dividends paid to Class B shareholders...

Well, what's probably happening on the market right now is the origial Class B shareholders are selling their Class A shares like crazy, in order to use the proceeds to buy more Class B stock, so that their voting rights are not being diluted with the new split, or gain even more voting rights (hey the two stocks trade at almost the same price, why not have more of the one with more votes?)

Me, like an idiot, bought into the Class A shares, thinking the value of the two should converge on technicality, because a 16.5% discount is a little steep... AND I DID THIS WITHOUT SHORTING THE CLASS B SHARES--Ameritrade doesn't offer that option :( So, as the Class B gets lower and lower--probably from a strong selling reaction on the Class A--Class A followed suit. And I'm left with a big REFLEXIVITY fart.

For everyone who doesn't know what "shorting" means... it is generally a strategy that daring and intelligent investors use to make money on FALLING stock prices. The investor generally goes to a broker and asks to "borrow" shares of stock--say at $100, and he sells the shares on the open market at the current price--while paying some interest to the broker that's negligible if he makes a killing. If the stock indeed did fall--say to $50. The investor can buy the shares back, and give the "borrowed" shares back to the broker, and then keep the $50 spread minus interest per share (if this is done with millions of dollars, you generally double your money. Get it?) So if I had shorted SPCHB, I would have made some pretty good money, even though I lost money on SPCHA, and the difference would have came up to be around 0.

Anyway, I mentioned reflexivity too...

(reflexivity means when two things happen at the same time, and they both CORRELATE and REINFORCE one another. Some really good examples are: Hedge Funds pulling out of Asia thinking the economy is bad, making the economy bad at the same time... Me pulling out of SPCHA thinking the stock is going to fall, making the stock price fall as I sell on a lower dollar value... and M.C. Escher's drawings... for more details on reflexivity, The Alchemy of Finance is a good read, and so is Godel, Escher Bach)

So, I'm left with another chunky loss on my PA (parent's account)... ever since that humongoloid gain I've had with Omni, I've been more and more daring to try new things--since my cusion is bigger for the next quarter...

If only I took more wise risks instead of stupid ones like these... URG!!!


P.S. Will the stock price bounce back up as a result of a stronger SPCHB in the future as buying continues on this stock, reinforcing the Class A shares again? Maybe... but there are better opportunities out there and I'm not one to wait around for this turnaround!

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