Chipotle's Vanishing Options

In 2015, Chipotle stock hit its peak price of about $758 per share, and executives owned stock options worth millions. Since then, the stock has plunged more 60 percent and executives have lost millions. For example, CEO Steve Ells lost $37.5 million worth of stock options, CFO Jack Hartung lost $34.8 million, and CMO Mark Crumpacker lost $10.7 million. In total, the four top executives at Chipotle, including former co-CEO Montgomery Moran, lost $225 million during the stock price plunge. These options were all granted before 2014 as Chipotle stopped issuing stock appreciation rights after shareholders criticized them as being too large and not linked to performance.

Currency Trading Shrinks...Maybe

So how much currency do you think is traded daily? According to a recent report published by the Bank for International Settlements (BIS), average daily trading in April 2016 was about $5.1 trillion! This was down from $5.4 trillion per day in April 2013. However, if the dollar had not appreciated over the period, average daily volume would have risen about 4 percent. Spot currency trades were about $1.7 trillion per day, swaps accounted for about $2.4 trillion per day, and the rest of the trading was for other over-the-counter foreign currency derivatives. The U.S. dollar was on one side of 88 percent of trades, while the euro was on 31 percent of trades.

Negative Yield Triangular Arbitrage

A question we often get is if the material we discuss is actually relevant to the real world. However, we can see the application of triangular arbitrage with the seemingly strange desire of investors to purchase the $9 trillion in below zero interest sovereign debt. A Japanese 3-month government bill is currently returning about negative .24 percent. The buyer can borrow at the yen 3-month LIBOR, which is about negative .02 percent and receive the dollar LIBOR at .82 percent. The buyer then executes a yen-dollar swap, which results in a dollar-hedged yield on the trade of 1.24 percent. With the 3-month U.S. Treasury yield about .25 percent, and increase in annualized return of about one percent is a huge increase for portfolio managers.

Delta Loses Big On Fuel Hedge

Companies with significant risks, such as currency or commodity risks, often hedge exposure to that risk. An industry with a a history of hedging is the airline industry, with companies often hedging fuel prices. However, not all hedges make money. For example, Delta Airlines recently announced that it lost $450 million on its fuel hedges in the second quarter of 2016 as it closed all of its hedges for the year. Delta is not alone as other airlines such as U.S. Airways and United have abandoned fuel hedges, citing lower fuel prices. We would like to point at that lower prices are not a good reason to eliminate hedges. By eliminating its hedges, Delta is now subject to the risk of increasing fuel costs. A hedge is designed to reduce volatility, so a reason to not hedge is the lack of volatility, not low prices, a fact often missed. Looking at the quote in the article from CNN Money: “Fuel prices are up 60% from their January lows, but they’re down 20% from a year ago. So, even with the cost of canceling its fuel contract, Delta will save money on fuel … in the second quarter.” While we agree that Delta will make more money with lower fuel prices compared to January, if fuel prices increase, Delta will not make as much as they could have going forward.

Spinoffs And Bondholders

In 2014, there have been 57 spinoffs by nonfinancial companies, an increase from 44 and 33 in 2013 and 2012, respectively. Many spinoffs are done for the benefit of stockholders. On average, a company that undertakes a spinoff sees its EBITDA increase by one percent between the announcement and the end of the next fiscal year. But the news for bondholders isn't as good. For one-third of the spinoffs since August 1, 2013, S&P has lowered the credit rating or put the company on a negative creditwatch. S&P notes that in spinoffs, there is often a decrease in cash flow without a corresponding reduction in debt. And, in the case of Symantec, S&P has the company on a negative creditwatch due to diminished business diversity (read diversification, or the coinsurance effect.) 

Employee Stock Options And Diversification

In the 1970s, CEO compensation consisted of about 16 percent in stock options, but in 2011 that percentage had risen to 60 percent options and other equity awards. Similarly, many other employees have been awarded employed stock options (ESOs) in recent years. While it is possible to get rich by holding all of your ESOs, it is also risky. As a recent article in The Wall Street Journal points out, not only are you exposed to the risk of the company with the options, but through your salary as well. One strategy to consider is selling ESOs and buying a diversified portfolio or mutual fund. So when to sell ESOs? One investment adviser argues that they should be sold when the time value of the option is less than one-third of the total value. The argument for this trading trigger is at that point there is not a lot left to gain, but a significant amount to lose. http://online.wsj.com/article/SB10001424052702304458604577490580206500166.html?KEYWORDS=playing+your+options