Short-Selling During the Coronavirus

Steve Eisman in Michael Lewis’s The Big Short – “In 2008, it was the entire financial system that was at risk. We were still short. But you don’t want the system to crash. It’s sort of like the flood’s about to happen and you’re Noah. You’re on the ark. Yeah, you’re okay. But you are not happy looking out at the flood. That’s not a happy moment for Noah.”

There’s a third type of investor during these times: the short-sellers.

I didn’t intend to become someone who makes money from suffering from others. It’s a mindset some people have, gained often through negative life experiences, a desire for truth, or just genetic skepticism. For me, it’s the first two.

That said, I’ve been having my most profitable month in the stock market at a time when many people have been panicking.

This is because, in January, I took short positions on four companies:

  • Fleetcor (FLT): For its looming FTC fine or lawsuit
  • Peloton (PTON): At risk of becoming the next GoPro and Fitbit (a hardware company that will get commoditized, even as the company claims it’ll make it up in content subscriptions)
  • Tesla (TSLA): There was undoubtedly going to be a pullback this year after the tripling in 2019
  • Uber (UBER): Their contractor employment model has been under regulatory attack and the UberEats business is competing with Grubhub and Doordash for slim margins

Below are the exact puts with strikes and expiration as of Thursday, March 5th. I cashed out half of my FLT May 15 position Thursday and Friday. I will almost surely close out all of these before the expiration dates.

March 5 2020 Portfolio

Important note about these shorts: None of them were specifically because their businesses would be directly impacted by the coronavirus (like the airline or cruise ship industries are). I’m sure some smart traders have made coronavirus-specific calls (shorting airlines or buying up biotechs). My approach is to have a list of companies that are already teetering on the edge of a cliff and are prone to drop with one piece of bad news, any news. This way I can stay generally right longer-term without having to try timing the market or the news cycle.

I could be accused of talking my profitable book after-the-fact. My counter to that: The reason I publish stock research posts is to go on the record so anyone can look up how my picks performed, and I already have a history of publicly announcing short positions. But it takes time to write thorough reports for public consumption and I have a busy day job. Given the history, it should be presumed that I either have some short positions or am considering some at any time.

I could be considered lucky and cherry-picking results. To that I’d say that, there’s always some luck involved in life. However, the profit model of having a short option portfolio is to capitalize heavily on the “black swan” events. You may not know exactly when they will occur, but you can know which companies and systems are fragile to negative shocks.

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Anyone can email or tweet me any time asking about my positions. A caveat is that if you ask me off-hand about a company, I might have an opinion but that does not mean I would short them or put money on it.

This seems like the right time to make the case for short-selling as a tool everyone should at least have in their box and the philosophy behind my approach. If not for this current market decline (I have no prediction on when it will end), then to be prepared for the future when this inevitably happens again.

First, what I’ve been jokingly calling my Speculative Short Fund is not my only investment strategy. I maintain a 401K that is long both markets overall and individual stocks (Google, 3M, Gilead, and Bausch Health are some I own).

Second, shorting is a component of risk-management, and I believe it can apply to individuals. One the reasons “hedge” funds are called such is their ability to balance the risks of investing by having protection for when the market declines. That’s short-selling (and other vehicles like derivatives and insurance that are less accessible for individuals).

Third, the reality is that a larger percentage of public companies (more than the average person would guess) in the past decade have underperformed. If you had invested your money to track the S&P 500 the past decade, a lot of your gains came from only a small handful of big tech companies. The rest of American industry has not necessarily done well. So if you don’t bet against Facebook, Amazon, Apple, Google, and Microsoft, then it’s a lot less likely that you’ll blow yourself up.

Fourth, from a trading execution perspective, I do not short the “common stock”, because that is how you can blow yourself up. I exclusively use Put Options to limit my exposure.

Fifth, being a short-seller is not the only way to make money in a declining market. Never forget the old age of “Buy Low, Sell high”. If stock prices are declining and you will be primarily a buyer of stocks in your lifetime, then you should not be worried when prices decline, as Warren Buffett made clear in this University of Florida speech:

“Any feeling I have about the market is not reciprocated…. Practically everybody in this room is going to be a net-buyer of stocks over the next ten years than they are a net-seller. So every one of you should prefer lower prices. If you’re going to be a net eater of hamburger in the next ten years, you want hamburger to go down unless you’re a cattle producer….New York Stock Exchange is a big supermarket of companies and you’re going to be buying stocks. What do you want to have happen? You want those stocks to go down, way down. You will make better buys then.”

Sixth, I do not consider myself cynical or anti-business. If that were the case, I would not have worked at multiple venture capital-backed, early stage startups. As Bonasera said to open The Godfather, I believe in America. Humans will continue to innovate to improve their lives, and that will translate into wealth. But it’s also important to acknowledge that there immoral or stupid people who happen to get control of power in certain aspects of the economy, specifically publicly-traded companies, and they will destroy wealth.

Lastly, short-selling is not about making money from other people suffering. It’s about keeping company management honest and serving financial justice to bad people. Take the Fleetcor example. There are serious fraud allegations about the company stealing money from customers without them realizing it.

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The coronavirus may only be coincidentally dropping the stock price 25% back to the correct value, but its impact will test whether the management knows how to run an ethical, smart business without lining their own pockets during times of easy money.

In conclusion, I am not saying specifically that you should start shorting now. It’s entirely possible we’re at the bottom of this correction and the broader market will be back up next week.

I am saying that if you always have an eye out for overpriced and/or fraudulent companies, betting against them can provide you profits and ease of mind when everyone else is losing theirs. I never feel guilty making money from correctly valuing a business, even if my stance is that it’s a bad, overvalued one.

If this is a topic that interests you, these are the books I would recommend reading to learn more: