The 285% Stock Trade

Back in September 2020 I mentioned a stock trade that I had executed and estimated at having an 80% chance of roughly tripling and a 20% chance of going to zero. I said that if anyone asked about it I’d write a debrief, so I’m going to go over it in detail here. The reason I didn’t write about it earlier was because I didn’t necessarily want people to follow me into the trade, as I’m not an expert on stock trading and thought that it was possible I was missing something.

If you’re a shareholder of a cruise company (there are three major ones) and you hold 100 shares of their stock, you get an onboard credit on every cruise you go on. I go on a lot of cruises, so this is a big benefit to me. Cruise stocks had gotten so high pre-pandemic, though, that I didn’t actually hold them for long. Usually I’d buy the stock before the cruise, get the credit, and then sell it later.

When the pandemic hit and cruise stocks got smashed, I decided to just buy 100 shares of each one and hold them no matter what so that I could always get the cruise credit.

As I poked around, I noticed something interesting, though. Norwegian Cruise Lines was priced at $9.87, but a $10 call option dated 18 months in advance was $6.38.

That means that I could buy a share of the stock for $9.87 and immediately sell someone a call on it and receive $6.38 (65%) back. The call is basically the right to purchase my stock for $10 at any point in the following 18 months.

So if I buy one share for $9.87 and immediately sell the call and get that $6.38 back, that means that I’ve really only spent $3.49 for a share of NCLH that will sell for a maximum of $10. I could then use the money I got from selling the options to buy another round of NCLH and sell the options on it until I got all of my money in.

If the share price dropped all the way down to $3.49 I’d break even (the option would expire as worthless and I could sell the stock for the same $3.49 that it cost me). If it went below that, which I estimated to only really be possible if the company went bankrupt, I would lose my money. If it was at $10 or higher in January 2022, I would make about 285%.

Because I’d make good money on anything short of bankruptcy, my next task was to figure out what the chance was that NCL could go bankrupt. I looked at their balance sheet and estimated that even if they didn’t sell another cruise until the options expiration day, they’d have enough cash to stay afloat. I also searched around to read opinions on cruise stocks, the industry, etc., to see if there was anything I hadn’t thought about, but couldn’t find anything. I also called a friend who is an options trading expert to make sure my understanding of the possible outcomes was correct.

I’m not an expert at reading balance sheets or understanding big companies, so I assumed that there was about a 20% chance I was missing something despite my research.

To calculate the EV I assumed 20% chance of losing 100% and an 80% chance of increasing by 285%, which gave me an EV of about 200%.

It’s extremely rare to find a low variance opportunity that returns 200% in 1.5 years, so I put my entire stock portfolio and IRA portfolio into this. Unfortunately neither was a particularly large account as I was not very into the market at the time.

As it turns out I bought the stock near the very bottom of the market and never in the 18 months did it approach a point where I wasn’t on track to make the full profit. The options expired a few days ago, they were exercised, and I booked a 285% profit.

However, just because I won on this stock trade does not mean that I was actually right. The way the options and stock were priced would indicate that that NCL had a roughly 65% chance of going bankrupt. It’s entirely possible that I don’t know how to evaluate balance sheets or companies and that I just happened to get lucky and we hit the 35% chance it didn’t go bankrupt.

But if I was right and the chance of the line going bankrupt was less than 65%, why would things be priced this way?

My best guess is that the sudden drop caused a frenzy of people wanting to speculate on it rising again. If it went back up to the $55 price point it was at before the crash, buying the stock would net you a 557% return, but buying the option would get you a 707% return. So if you just want to speculate, buying the option can be even better.

I have a deeply held belief that an average person cannot beat the market by picking individual stocks, and that belief also generally holds for options (though options are a great tool for shifting variance in useful ways). However, when I saw something unusual I investigated it anyway and founds something that seemed like an opportunity. I’ve looked around a bit for other similar situations and haven’t found anything, so it seems that if it was indeed a +EV opportunity, it was a product of a strange time.

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Photo is Greek ruins from the British Museum. I remember them being from the parthenon, but that seems maybe not true?

Now that this stock trade is over I deployed all of the money back into the portfolio I describe in my Billionaire series.

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18 comments

  1. Another update on Tynan’s voyage to Antarctic. We are still attempting to make contact with him, but so far there has been no response. Obviously things are not looking great right now but we are trying to stay optimistic.

      1. They must be pre-written or he is getting someone else to do it. There’s some truth in his voyage for lunar research.

  2. “However, just because I won on this stock trade does not mean that I was actually right. ”

    Your intellectual honesty is awesome. It’s one reason why I look forward to hearing your thoughts and opinions. This situation reminds me of Annie Duke’s warning against “Resulting” in her book, “Thinking in Bets”.

    Congrats on the trade!

  3. The British museum has pretty much the entire front face of the Parthenon. There museum in Athens only has copies, and they’re quite salty about it

    1. Perhaps they should have thought about that before they decided to fill the Parthenon with gunpowder… The whole thing was blown to pieces a few centuries back and all that’s left is a sad relic of the original structure.

  4. Actually the temple you have posted is not the Parthenon (only part of that is in the British Museum). It is the Nereid, a Persian temple that came from modern Turkey. Any Persian might be quite angry to see the confusion 😉

  5. Congrats on the trade Tynan. As Adam wrote, good to know when you don’t know everything; even better when you have a methodology to evaluate a decision with incomplete information.

    If I can ask: on a relative/percentage basis, how did this “all in” trade compare to your total assets (less debt). I think contextualizing this trade a bit for the audience might help and I’m certainly curious. While I’m sure it was a big bet, it’s worth noting whether or not you ‘risked the farm’ so to speak.

    Thanks as always dude!

    1. In this particular case I would have bet more if I could have, but didn’t have cash available for it. I probably would have bet 1/3 of net worth on it if I could have, though it’s also hard to really say in retrospect. In reality I think I bet less than 10%.

  6. I think the missing piece is that the market is ruthlessly forward looking. At the end of 18 months, if it looked like NCLH was heading towards bankruptcy (or they diluted heavily to raise cash, etc.), the value of the shares would be well below your $3.49 breakeven even if the company was not imminently going bankrupt.

    1. Actually, since the trade he’s describing is a covered call, his theoretical profit would only be 66% (not 285%), since the profit of a covered call is capped at the strike price of $10.
      Assuming he meant he bought 100 shares of NCLH, his profit on the shares would be $13 when it reaches the price of $10, plus the $638 of the short option premium, therefore only 66% ($648/$987 =66%).
      Assuming the option buyer would only exercise if the stock reaches > $16.38 (to break even on their call debit), Tynan’s profit could in practice go up to 130% = [($16.38-$9.87)*100+$638]/$987

      1. Actually, scratch my last sentence, the call buyer would still exercise when the stock reaches at or above $10, meaning the profit is indeed capped at 66%.

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