Thursday, August 28, 2008

LDK - Notes on Options - 8/28/08

This idea has been rattling around in my head for some time. Here are some thoughts. Take them as purest opinion and speculation. If they are fundamentally unsound, then give me hell.

The question is, what have the Options Writers been doing, and what are they doing now?

Well, the trend since October '07 has been that puts have been golden. LDK has nearly on every occasion dropped to or below Max Pain for options expiration.

"Max Pain" is the point of intersection between the interests of Call Writers and Put Writers.

In the case of Calls, if the Price of the stock goes above the Strike Price of the Call, then the Call Writer has to deliver 100 Shares of Stock to the Call Buyer (if they Buyer Chooses to take them). The Call Writer DOES NOT WANT the price of the shares to pass the Strike Price of the Calls that he has written and sold. Some Call Writers don't even have the shares to deliver. In the case that their calls get into the money, these guys would have to buy shares to deliver sometime after OE (or else be in possession of other Calls that were also in the money).

This puts it in the interest of Call Writers for the Price of Shares to Drop (or stay below the price of the Written Contracts, anyway). It puts Call Writers on the Short Side.

What about the writers of Puts? The Writer of Puts is somewhat the opposite of the Call Writer. The Put Writer says to the Put Buyer that if the Share Price of the Stock goes BELOW the Strike Price of the Put that has been Written and Sold, then the Put Writer will BUY 100 Shares of Stock from the Put Buyer (if the Buyer Chooses to sell them). The popular idea here, is that a person would Buy a Put in order to protect themselves in the case that the Price of the Shares Decreases. If the Price of the Shares Goes Below the Strike Price of the Put, then the Put Buyer will Sell the Shares to the Put Writer for the Higher Strike Price.

This would seem to suggest that the Put Writer would be interested in a Rising Price, and would be on the Long Side.

Now, if the Put Contract were truly the opposite of the Call Contract, then clearly, just as the Call Writer does not want their Calls to come into the money, neither does the Put Writer; i.e. where the Call Writer wants the Price Down, the Put Writer wants the Price Up.

This is the basis for Max Pain, but is it accurate? Maybe not always.

What if the Put Writer Actually Wants or Needs the Shares? They could be perfect happy to Deliver on their In the Money Put Contracts.

Consider a situation where there are very few shares to go around (Low Float, Dedicated Long Holdings), and an incredible level of Short Interest that needs to protect itself from a Squeeze. In this case, the last thing that the Short Interest wants to do is to buy Shares on the Open Market, as these Transactions would create significant Upward Pressure on the Share Price. However, in order to have control of the Price, Short Interest must have Shares to Strategically Dump.

If the Put Writer really wants those shares, then they might very well be perfectly willing to let the Puts end up In the Money and to collect the resulting Shares. They make the initial income from Selling the Put in the first place, and then on Options Expiration Day, they could collect 100 shares of Stock per Contract without undue buying pressure on the Open Market Price of the Shares.

Of course, the Buyers of the Puts would be happy with the deal, because they managed to sell their shares at a lower level of Loss (percieved).

This would be exactly what the Short Doctor Ordered; Sell Puts, Drive the Price Down, Collect Shares. It's a Win, Win, Win situation for Short Interest.

The Next month, they can then repeat the process, and use the Shares Collected in the Previous Month to Dump on the Open Market, and Drive Down the Price as Necessary to bring the Next Wave of Puts Into the Money.

It's a Vicious Circle, and could Explain why, on a couple occasions LDK Shares ended up more than $5 below the Max Pain Price.

Q2 LDK Earnings caused a failure in this Short Process.

Nobody had any idea that LDK was going to Blow Away Expectations like they did. Many eyes moved to see LDK for the first time, and Many More have looked this way Since. The Price went from $33 to $42 in Five Days up to August OE, knocking out the $35 and $40 Strike Puts. I don't have access to an Options Chain from August, but I did record that between $30 and $40 Puts for August there was a total Open Interest of 23313 Contracts. Whether there was any possibility of taking this Stock below $30 had LDK announced mediocre results, who knows, but I think it's safe to say that the losses of the $35's and $40's unexpectedly deprived Short Interest of over a Million Shares that could have been used for Dumping in September.

This is not to mention the Calls that had been bumped into the Money, for which either Shares would have to be Delivered, or additional Calls would have to be purchased to cancel the debt. Either way there would be a cost to the Short Side.

Looking forward to September.

Well, obviously the August Share Price Movement since Earnings has been incredible. How much of this has to do with the repercussions from the August Options Scenario, is unknown. I think it's safe to say, though, that Short Interest is suffering.

August Options Losses, however, are miniscule compared to the potential Risk that the Short Side faces in September. A week ago it was looking possible that Put Writers could lose their $45 Strike Puts, and now it's looking possible for them to lose the $50's. Again, this is not even to mention the cost of Delivering Shares on In the Money Calls at these higher Strikes.

How does Short Interest Deal with this?

I have no freakin' idea! LOL!

The threat to Short Interest of Poly Production hangs over the Stock. Poly Production is the Key in the minds of a great many Investors. Jesse Pichel has said that he believes that they will FAIL. Where Earnings were worth an immediate 20% added to the Share Price, Poly Production (or even other pieces of wholly unexpected news, for that matter) could add 20% OR MORE between refeshes on the screen.

For Shorts to avoid massive Options Losses, the price has to be driven down in September. On the other hand, to do so will require the dumping of shares, which carries with it incredible additional risk based on the Timing of LDK's Poly Announcement. Even if the price could be brought back down to, say, $39, a 20% rise on News from LDK would pop it right back up to $46, bringing the 40 and 45 Strike Calls right back into play. As of today, just those two Strikes amount to almost 22 Thousand Contracts, or the equivalent of 2.2 Million Shares. So, what if Short Interest Dumps a Million or more Shares in order to save on 2.2 Million Shares, and they Fail? I'll leave that to the reader's imagination / calculation.

What can Longs do?

Not that I am advising in anyone's personal investment decisions, but I think that there are some things that could concievably be done to support the Price through this time. Call it "common sense." Remember that each potential investor is absolutely responsible for their own investing decisions, and I am not liable for any potential losses or other repurcussions from those decisions.

One, be careful. Recognize that when Short Interest buys the price up, they'll do all that they can to then sell it back down. Don't go out on a limb on Margin on a spike in the price. Emergency Selling on the Downside suits Short Interest by generating Fear and Losses from Longs. Avoid the temptation to buy on Margin by making sure that you have your desired position PRIOR to the big moves that we're looking to see as this Short Interest unwinds.

Two, don't use stops. Stops, in this case, have been consistantly used by Short Interest to trigger chain reactions of Selling. If you know the facts of this case, and are confident enough to buy shares, then great, but if you are investing with such fear of short term loss that you need to put up a stop to be triggered, then maybe you'd better go find a different Stock to buy.

Three, don't forget the Fundamentals. For a reminder, see the July Presentation Slides. These Fundamentals ultimately define the Value of LDK, and the day to day ticks are of Secondary Importance. It is these Fundamentals that give you the comfort of Confidence that your money invested in LDK is likely to grow over the long term.

Four, for Traders, having looked at the Fundamentals, as well as at the history and projected future of this Company, recognize that though buying and selling short-term dips and peaks can increase the profits of a skilled trader; missing the rapid rise of a Short Capitulation would be a damned shame. Holding a core position safe from trading might make sense.

Five, spread the word. This story, the LDK Story, the Global Solar Story, and even the Climate Change and Peak Fossil Stories are incredibly important for people to understand. Without understanding of the Problems and Solutions, is it any wonder that people are unable to properly determine the market value of the Relevant Businesses?

As usual, Comments / Questions / Disagreement is welcome.

Final Late Night Edit: LDK has just announced ANOTHER contract WITH PREPAYMENT from Hyundai Heavy Industries for 440MW of Wafers over 7 Years Starting in 2009. This even more greatly complicates the Calculations for Short Interest on LDK.

LDK has developed a clear pattern of offering Contracts for future Production, in part, based upon Immediate Partial Prepayment in support of the Growth that LDK will need to fulfill those Contracts.

This strongly supports LDK's position by not only assuring LDK a supply of Capital for Growth, but by doing so without the Need for Dilution on the part of LDK. There are clearly no new shares coming onto the Market for shorts to use in covering.

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