2006 FFH Options Bet

[meiroy]

Thank you guys for writing so clearly about your experience and allowing us to learn from it. 

 

A couple of questions/thoughts:

 

1. Your comments might explains clearly why you thought the company risk is limited, yet even in such a situation how could someone be invested 100% considering there's also the market risk and a possibility of a permanent loss of capital?  It's fantastic to see that it worked out though.

 

2. This applies to BAC as well, especially what's going on in Europe right now where it's highly likely it will at least partially collapse. You could be completely right about BAC's individual risk and still encounter complete loss of capital due to market risk.

 

3. In another thread someone calculated that the warrants (A I assume) would yield 40% more than the commonat expiration date, even if the final number would be even higher due to dividend/common per warrant adjustment, is the risk:reward worth it considering a permanent loss of capital?

 

4. Before reading this thread, I read quite a few post showing some  hatred towards the short-sellers. Regardless of why they did what they did it seems it created an amazing opportunity for individual investors.  Wouldn't mind it happening to one of the stocks I'm following...

 

 

 

[twacowfca]

Thank you guys for writing so clearly about your experience and allowing us to learn from it. 

 

A couple of questions/thoughts:

 

1. Your comments might explains clearly why you thought the company risk is limited, yet even in such a situation how could someone be invested 100% considering there's also the market risk and a possibility of a permanent loss of capital?  It's fantastic to see that it worked out though.

 

2. This applies to BAC as well, especially what's going on in Europe right now where it's highly likely it will at least partially collapse. You could be completely right about BAC's individual risk and still encounter complete loss of capital due to market risk.

 

3. In another thread someone calculated that the warrants (A I assume) would yield 40% more than the commonat expiration date, even if the final number would be even higher due to dividend/common per warrant adjustment, is the risk:reward worth it considering a permanent loss of capital?

 

4. Before reading this thread, I read quite a few post showing some  hatred towards the short-sellers. Regardless of why they did what they did it seems it created an amazing opportunity for individual investors.  Wouldn't mind it happening to one of the stocks I'm following...

 

You are right.  The short sellers were key to how well this worked out.  The short interest was huge.  They were financing their short sales of the stock by selling FFH calls.  Consequently, the price of the calls had become dirt cheap, while puts were very expensive. 

 

Our strategy in buying FFH calls was the inverse of Ericopoly's.  We tippytoed into the position, and then increased position size enormously as favorable developments worked out. We quadrupled the position as the hurricane season was petering out and the SEC investigation fizzled out.  As the stock price rose, I sniffed a short squeeze when one of the short sellers' ''investigators' was charged with fabrication of evidence. 

 

We piled on and increased our investment in calls many times, by purchasing leaps because things very likely would continue to  get even worse for the short sellers.  I was reminded of a scene I had witnessed years before when a professional poker player had cleaned out an unfortunate sucker by bluffing and intimidation.  But this time the pros (the short sellers) held the suckers hand.  I realized their weakness, and we bought even more calls when the shorts began to cover as indicated by the increase in implied volatility of the FFH calls.

 

The implied volatility of the calls finally went down as the price of the stock approached $200/sh.  The amount we were receiving to lend our  FFH shares to the short sellers dropped into the low single digit percentages.  That was the first time in two years that we were getting less than a double digit percentage rate to lend our shares.  This indicated that the shorts were no longer paying a big premium to short the stock or buy back the calls they had sold cheaply.  It was time to take profits as the short squeeze was apparently over. 

 

We didn't take most of our profits until FFH passed $185.00 In price, holding some of the leaps for even greater gains a few months later.  It was a huge coup, between 8 to 30 times what we paid for the calls, depending on our entry points.  :)

 

 

[Uccmal]

I concur with what Sanjeev says above.  Bac is vastly easier to analyze.  By the time Of the options bet I had met Francis, and two or three other FFH executives and was struck by their honesty, and loyalty to Prem.  Sanjeev had met Prem, who went out of his way to reach out through Sanj to our little suffering community here.  In my day job alot of people lie to me or cover up with half truths.  I didn't see that with these guys at FFH.

 

  I was reminded of a scene I had witnessed years before when a professional poker player had cleaned out an unfortunate sucker by bluffing and intimidation.  But this time the pros (the short sellers) held the suckers hand.  I realized their weakness, and we bought even more when the shorts began to cover as indicated by the increase in implied volatility of the FFH

 

It was a bit like poker.  Still is.  I always thought the analogy to poker in terms of ability to card count.  Now, I see it more like the Kenny Rogers song - The Gambler. 

[Guest Dazel]

 

Sanjeev,

 

We will agree to disagree. We owned Fairfax when their leveraged investment portfolio moved....and that was related to their large U.S treasury holdings....it later moved to their CDs portfolio...a liquidation would given great results.

 

Bank of America assets are impossible to quantify...their derivative portfolio and corporate structure make Fairfax look like kindergarden work.

 

However, their deposit base and brand are worth a lot...to us much different than Fairfax. We would argue with you that there is much more upside to Bank of America.

 

For Fairfax when the market saw the earnings that were produced by investments the stock moved... but we already knew what the investments did from the bond yields. We would sell at that point. Fairfax business is and was tough. You say Prem...but our hero was Brian Bradstreet. Of course Prem was the leader we agree. We hope to once again get a chance to own Fairfax as it was the team that produced the results.

 

It will be the brand that wins out for Bank of America if it is to once again flourish.

 

 

 

 

[twacowfca]

I concur with what Sanjeev says above.  Bac is vastly easier to analyze.  By the time Of the options bet I had met Francis, and two or three other FFH executives and was struck by their honesty, and loyalty to Prem.  Sanjeev had met Prem, who went out of his way to reach out through Sanj to our little suffering community here.  In my day job alot of people lie to me or cover up with half truths.  I didn't see that with these guys at FFH.

 

  I was reminded of a scene I had witnessed years before when a professional poker player had cleaned out an unfortunate sucker by bluffing and intimidation.  But this time the pros (the short sellers) held the suckers hand.  I realized their weakness, and we bought even more when the shorts began to cover as indicated by the increase in implied volatility of the FFH

 

It was a bit like poker.  Still is.  I always thought the analogy to poker in terms of ability to card count.  Now, I see it more like the Kenny Rogers song - The Gambler.

 

Your reference to card counting is spot on.  It's a lot more about game theory than mechanical computation of odds.  I know an old time blackjack card counter who got a galley proof of Beat the Dealer before it was published,dropped out of school and started playing in casinos before 99% of pit bosses knew about card counters.  This guy can count every card in a six deck shoe, not just the aces and tens, but he says counting ability is merely a small part off the success formula.  It's much more important to know the opposition and what they can do to you such as cheating and to pick targets when the deck won't be stacked against you and disguise your play.

[Parsad]

Sanjeev,

 

We will agree to disagree. We owned Fairfax when their leveraged investment portfolio moved....and that was related to their large U.S treasury holdings....it later moved to their CDs portfolio...a liquidation would given great results.

 

Bank of America assets are impossible to quantify...their derivative portfolio and corporate structure make Fairfax look like kindergarden work.

 

Hi Dazel, not quite true.  The net derivatives risk at BAC is quantifiable and relative to the deposit and lending base, or even shareholder equity, is relatively small.  It's not nominal we are worried about, but net exposure.

 

For Fairfax when the market saw the earnings that were produced by investments the stock moved... but we already knew what the investments did from the bond yields. We would sell at that point. Fairfax business is and was tough. You say Prem...but our hero was Brian Bradstreet. Of course Prem was the leader we agree. We hope to once again get a chance to own Fairfax as it was the team that produced the results.

 

Yes, definitely it was a team effort.  But the credit for the CDS idea belongs to Brian and Francis...but no one really knows that.  Francis came up with the original idea, but Brian was the one who brought it up in the committee meeting when Prem was asking the team for good ideas.  And then it had to be a unanimous decision for the committee to approve it.  Interestingly enough, Francis owns alot of BAC warrants and he's never sold a single Fairfax share. 

 

It will be the brand that wins out for Bank of America if it is to once again flourish.

 

If they are modelling themselves after Wells Fargo, then I'm guessing it will be good business sense as well.  The reduction in leverage, shrinking of their book of business, and focus on basic banking seem to suggest that it is occurring.  Cheers!

[ubuy2wron]

It seems that some here have made the start of their fortunes with large bets on FFH options. It seems that sizeable fortunes are ONLY made if you are willing to go ALL IN at some point in your life with enough capital that the pain of being wrong is great. The spoils of life only go to the brave and the foolish and history is pretty much a record of the winners not the losers I doubt if the people on the other side of the FFH option trades are posting on investment sites tales of  how stupid they were in selling those call options and sharing their insight with others. What is apparent is that FFH had a VERY large margin of safety in 2006 if you assumed that FFH was not run by shysters.

  I was aware of FFH in 2006 and was smart or lucky enough to buy some around 100 per share I never in my wildest dreams however felt that it would be trading @ 400 a few short years later. I sure could use some insight on how to have the conviction to stay with what turns out to be a great trade or investment far too often I am second guessing myself and selling postitions that have only just begun to ripen. It is not the big losses that kept the private jet and the beach house out of my grasp but the fore gone profits from selling to early.

[twacowfca]

It seems that some here have made the start of their fortunes with large bets on FFH options. It seems that sizeable fortunes are ONLY made if you are willing to go ALL IN at some point in your life with enough capital that the pain of being wrong is great. The spoils of life only go to the brave and the foolish and history is pretty much a record of the winners not the losers I doubt if the people on the other side of the FFH option trades are posting on investment sites tales of  how stupid they were in selling those call options and sharing their insight with others. What is apparent is that FFH had a VERY large margin of safety in 2006 if you assumed that FFH was not run by shysters.

  I was aware of FFH in 2006 and was smart or lucky enough to buy some around 100 per share I never in my wildest dreams however felt that it would be trading @ 400 a few short years later. I sure could use some insight on how to have the conviction to stay with what turns out to be a great trade or investment far too often I am second guessing myself and selling postitions that have only just begun to ripen. It is not the big losses that kept the private jet and the beach house out of my grasp but the fore gone profits from selling to early.

 

There have been four times when we have gone all in to a seemingly risky situation with more than 50% of our assets invested in one company.  One was in a bankruptcy when a plan of reorganization had been confirmed. The other three were companies like FFH where an ethical, respected CEO or dominant shareholder had most of his personal assets invested in the company or a huge chunk of stock.  These companies also had other major investors or important friends who stood with them and helped them through their difficulties.

 

Having a group of respected investors who are willing and able to help a CEO when times are tough is a powerful predictor of success for a business with good economics and potentially solvable problems.

 

 

 

 

[Parsad]

It seems that some here have made the start of their fortunes with large bets on FFH options. It seems that sizeable fortunes are ONLY made if you are willing to go ALL IN at some point in your life with enough capital that the pain of being wrong is great. The spoils of life only go to the brave and the foolish and history is pretty much a record of the winners not the losers I doubt if the people on the other side of the FFH option trades are posting on investment sites tales of  how stupid they were in selling those call options and sharing their insight with others. What is apparent is that FFH had a VERY large margin of safety in 2006 if you assumed that FFH was not run by shysters.

  I was aware of FFH in 2006 and was smart or lucky enough to buy some around 100 per share I never in my wildest dreams however felt that it would be trading @ 400 a few short years later. I sure could use some insight on how to have the conviction to stay with what turns out to be a great trade or investment far too often I am second guessing myself and selling postitions that have only just begun to ripen. It is not the big losses that kept the private jet and the beach house out of my grasp but the fore gone profits from selling to early.

 

Terrific post Ubuy2wron!  Cheers!

[Uccmal]

It seems that some here have made the start of their fortunes with large bets on FFH options. It seems that sizeable fortunes are ONLY made if you are willing to go ALL IN at some point in your life with enough capital that the pain of being wrong is great. The spoils of life only go to the brave and the foolish and history is pretty much a record of the winners not the losers I doubt if the people on the other side of the FFH option trades are posting on investment sites tales of  how stupid they were in selling those call options and sharing their insight with others. What is apparent is that FFH had a VERY large margin of safety in 2006 if you assumed that FFH was not run by shysters.

  I was aware of FFH in 2006 and was smart or lucky enough to buy some around 100 per share I never in my wildest dreams however felt that it would be trading @ 400 a few short years later. I sure could use some insight on how to have the conviction to stay with what turns out to be a great trade or investment far too often I am second guessing myself and selling postitions that have only just begun to ripen. It is not the big losses that kept the private jet and the beach house out of my grasp but the fore gone profits from selling to early.

 

Lucky = Being born in a middle class family in Canada

 

Unlucky  - being a FFh shareholder going into 2002/2003

 

Smart - using google and typing in Fairfax Financial and finding the MSN Berk Board

 

Lucky/smart - printing off a picture of Sanjeev and finding him at the 2004 AGM, after he first met Prem.  Meeting other board members at same meeting as well as speaking with Roger Lace and Bill Joyner at the AGM.  The next year Sanj. held our first pre-AGM dinner.  All the rest stems from these events.

 

Ubuy2wron: I think it is a matter of investing style and philosophy.  When I drift from my style, as I did last year, I dont do well.  With BAC I have gotten to know it since 2008/2009, first holding the warrants 2 years ago.  I have followed AIG in the news for a long time, and have a reasonable understanding of insurance.  I do investing related thinking/reading 2-3 hours per day, 340 days per year, for the last 15 years.  99% of the possibilities I review become just passing interest. 

 

Dazel: As a group we would try to decipher FFHs balance sheet, particularly the SwissRe, and Chubb Insurance (loans).  No one knew how to account for this at the time, or how to unwind the messiness of FFHs balance sheet.  The most we knew was that the FFh group were honest, hardworking, and smart.  The shorts only saw the balance sheet and grabbed ahold of it without really knowing the FFH culture.

 

 

 

[MVP444300]

I was a lucker on the MSN board when you guys where talking about investing in FFH commons and LEAPs several years ago.  I can kick myself for not looking into it further.    What is even worse I looked at it and saw that it was cheap.

 

I have made so many mistakes thumb sucking when I should have acted.  My other issue I have is when I see a bargains I don't act in a big way putting a large chunk of my net worth into an investment. 

[Guest Dazel]

 

 

Uccmal,

 

Yes of course it was a group effort. The analysis was wonderful. Everyone who invested in Fairfax had their own specific reason and they had to be comfortable with that thesis. I told you mine. When you had a company with a market cap of $1b and the bond portfolio had a billion dollar unrealized gain...we had an advantage. Regardless of what happened from the commutations and "finite insurance contracts"....The shorts could not dispute the investment gains and it took them down.

 

Everyone did a great job and I am forever grateful for the work the was done and for especially Sanjeev for putting it together. I certainly mean no disrespect to anyone.

 

And for the record I hope BAC does better!

 

Dazel.

[Uccmal]

Ubuy2wron, The other thing that comes to mind is that its easier to hold onto something that is working out, rather than trying to get to know new situations constantly.  Buffett is the master at this strategy.  Of course it doesn't apply to cyclical companies.

 

You may want to look at a copy of David Dreman's big book - Contrarian Investment Stategies. 

In it he shows how undervalued stocks as defined by P/B, P/E, P/cf, have market exceeding returns for 5 years or more after they start recovering.  The retrenchment work companies begin to do while they are undervalued continues to pay back for years into the future.  Dreman's a master statistician and his findings are phenomenal.  Berkowitz is good at recognizing this as well.  He knows that BAC will ultimately earn more than 3.00 per share. 

[Uccmal]

 

 

Uccmal,

 

Yes of course it was a group effort. The analysis was wonderful. Everyone who invested in Fairfax had their own specific reason and they had to be comfortable with that thesis. I told you mine. When you had a company with a market cap of $1b and the bond portfolio had a billion dollar unrealized gain...we had an advantage. Regardless of what happened from the commutations and "finite insurance contracts"....The shorts could not dispute the investment gains and it took them down.

 

Everyone did a great job and I am forever grateful for the work the was done and for especially Sanjeev for putting it together. I certainly mean no disrespect to anyone.

 

And for the record I hope BAC does better!

 

Dazel.

 

Dazel, I hope what I wrote was not defensive.  You were one of the people who helped me understand the situation.

 

It had nothing to do with disrespect.  It had more to do with my recollection of the unknowns we were operating under, which were significant.  Do you remember the "SEC has Watsa on a Short Leash Article".  I should look it up.

[Parsad]

What I'd like to see is what stories we tell when Prem is 80 years old, Fairfax is a $50B company, and Prem's investing prowess continues to gain notoriety. 

 

Old men with scratchy voices and painful bunions..."Remember Al, when we saved Prem and Fairfax with our six-shooters!  We took Chanos and Cohen down.  God-awful shorts!  Cardboard and LotsofCoke teamed up with Bsilly and walloped Brolgaboy and Peter Eavis.  Those were the days.  A man could make a fortune by betting it all on LEAPS and spitting with one eye closed!"

 

As you can see, I like Westerns!  Cheers!

[Uccmal]

and leaking peepees too.... lol.

[Guest Dazel]

 

Uccmal,

 

No offense taken...how could anyone that went through that time...take offense!

 

Dazel.

[Guest Dazel]

 

Sanjeev,

 

Could not agree more....I wish nothing but the best for all of Fairfax! What a Great family there!

 

Dazel.

[Aberhound]

In 2006 FFH was vulnerable to another bad insurance year. They had bad losses in 2001 from 9/11 and 2004 and 2005 from two back to back once in a 100 year bad Hurricane seasons. Further, Prem had not yet cleaned up the reinsurance he took out to save the company so the balance sheet might have been weaker than it appeared. The balance sheet must have been weak or Prem would not sold shares.

 

If it weren't from Sanjeev's confidence in the integrity of Fairfax's management I would not have made the bet.

 

I liked Fairfax's portfolio at the time and I did not agree with the short thesis that the reinsurance accounting was a big problem (thanks to Sanjeev).

 

I felt that if they did not suffer another bad loss year the share price would soon start returning to normal value (ie above book value). I suspected this would start fairly quickly, at least by February/March when we get to hear more wisdom from Prem.

 

If you read the short thesis, then looked at the FFH option market it was obvious the shorts were using the options to short the stock. This appeared to create absurd risk/reward opportunities in the option pricing. I also observed that hurricane insurance pricing had climbed sharply and Fairfax had reduced exposure so even if there were bad hurricanes, the loss would not be as severe as 2004 and 2005, yet the share price had dropped sharply, apparently in fear of another bad hurricane year or because of the huge short bet. I like people to short stocks which I want to buy.

 

I bought the options at $120 which were $3.60 vs. $2 which Ericopoly paid for the $140s. I sold about 1/3 after 20 fold gains and 1/3 about 40 fold then exercised the rest at expiry. I was only willing to risk about 20% of my portfolio on a leveraged bet. The $140s looked too risky to me at the time. I expected a 20% to 40% share price rise which caused the option pricing to offer an extremely attractive risk/reward. The huge and rapid rise in the share price was not expected by me and I attribute that to the genius of Prem and his team.

[T-bone1]

In 2006 FFH was vulnerable to another bad insurance year. They had bad losses in 2001 from 9/11 and 2004 and 2005 from two back to back once in a 100 year bad Hurricane seasons. Further, Prem had not yet cleaned up the reinsurance he took out to save the company so the balance sheet might have been weaker than it appeared. The balance sheet must have been weak or Prem would not sold shares.

 

If it weren't from Sanjeev's confidence in the integrity of Fairfax's management I would not have made the bet.

 

I liked Fairfax's portfolio at the time and I did not agree with the short thesis that the reinsurance accounting was a big problem (thanks to Sanjeev).

 

I felt that if they did not suffer another bad loss year the share price would soon start returning to normal value (ie above book value). I suspected this would start fairly quickly, at least by February/March when we get to hear more wisdom from Prem.

 

If you read the short thesis, then looked at the FFH option market it was obvious the shorts were using the options to short the stock. This appeared to create absurd risk/reward opportunities in the option pricing. I also observed that hurricane insurance pricing had climbed sharply and Fairfax had reduced exposure so even if there were bad hurricanes, the loss would not be as severe as 2004 and 2005, yet the share price had dropped sharply, apparently in fear of another bad hurricane year or because of the huge short bet. I like people to short stocks which I want to buy.

 

I bought the options at $120 which were $3.60 vs. $2 which Ericopoly paid for the $140s. I sold about 1/3 after 20 fold gains and 1/3 about 40 fold then exercised the rest at expiry. I was only willing to risk about 20% of my portfolio on a leveraged bet. The $140s looked too risky to me at the time. I expected a 20% to 40% share price rise which caused the option pricing to offer an extremely attractive risk/reward. The huge and rapid rise in the share price was not expected by me and I attribute that to the genius of Prem and his team.

 

I agree.  Due to the high short interest and difficulty to borrow, the premiums on put options were through the roof.  We were selling put options for huge premiums (I think we were getting more than $6 for the $60 puts, but I can't find my spreedsheet), and reinvested about half the proceeds into call options.  I don't recall having a lot of confidence that the calls ($130-$160 strike) would pay off, but thought it was worth the gamble due to the huge short interest (equal to the float at 4.2 million shares) and improving situation at the company.  I think we sold most of our calls for a 10-20X gain, but really didn't plan on such a windfall.  (I also was proudly wearing my tinfoil hat at the time and believed that SEC enforcement of Reg SHO could cause a massive short squeeze.  We had all of our shares in certificate form at the time so they couldn't be borrowed).

 

I think there was some luck involved in these huge gains that many on this board shared in (and yes, I also have this board to thank for getting comfortable with the investment although I was just lurking on the old MSM board at the time) due to the fact that there were no hurricanes that year.  At the time it seemed like there would be hurricanes, although now it seems obvious that there wouldn't be.  This investment seems like a no-brainer now, but at the time there had been a lot of negative surprises in the recent past.

 

I think selling the puts was really the great opportunity there - free money under almost any circumstance.  Buying the calls was more fortuitous than anything for me and I would have never done it if I wasn't selling the puts along with buying stock.

 

I have been looking for a similar investment opportunity ever since, as I'm sure many on this board have been.  I think the basic situation is best described as:

 

1) a large short interest where the shorts fundamentally don't understand the company (i.e. the shorts legitamately thought FFH was cooking the books and was insolvent)

 

2) an actual dramatic improvement in fundamentals, but just as importantly in transparency.  They stabilized run-off, cancelled the finite re-insurance contract with Swiss Re, restated past financials and got a clean bill of health from the auditors (not that they needed it), shored up the balance sheet by selling their Asian equities (in a very timely sale!), lowered re-insurance recoverable (and hedged the rest in the genesis of the huge CDS trade)

 

I have a company in mind currently that I think satisfies both conditions, but would love to hear of other companies that board members think fit this bill.  I think a company like RIMM probably satisfies the first condition, but not the second. 

[leftcoast]

I found these 2 threads from the old MSN board archive to be the most insightful in terms of how people were analyzing the situation at that time:

• FFH and subsidiary price difference  (June 16 - July 1, 2006)
  
• FFH option pricing  (June 24- July 15, 2006)
  

You definitely get the sense that the LEAPS were not considered a slam dunk at that time. The call options were dirt cheap and FFH was terribly (or wonderfully) undervalued, but there was still a lot of genuine concern about the market staying irrational and those $140 calls expiring worthless before FFH recovered.

 

Starting in the fall of 2006, you start seeing some threads discussing financial independence and the "escape velocity" needed to achieve early retirement.  :)

[twacowfca]

In 2006 FFH was vulnerable to another bad insurance year. They had bad losses in 2001 from 9/11 and 2004 and 2005 from two back to back once in a 100 year bad Hurricane seasons. Further, Prem had not yet cleaned up the reinsurance he took out to save the company so the balance sheet might have been weaker than it appeared. The balance sheet must have been weak or Prem would not sold shares.

 

If it weren't from Sanjeev's confidence in the integrity of Fairfax's management I would not have made the bet.

 

I liked Fairfax's portfolio at the time and I did not agree with the short thesis that the reinsurance accounting was a big problem (thanks to Sanjeev).

 

I felt that if they did not suffer another bad loss year the share price would soon start returning to normal value (ie above book value). I suspected this would start fairly quickly, at least by February/March when we get to hear more wisdom from Prem.

 

If you read the short thesis, then looked at the FFH option market it was obvious the shorts were using the options to short the stock. This appeared to create absurd risk/reward opportunities in the option pricing. I also observed that hurricane insurance pricing had climbed sharply and Fairfax had reduced exposure so even if there were bad hurricanes, the loss would not be as severe as 2004 and 2005, yet the share price had dropped sharply, apparently in fear of another bad hurricane year or because of the huge short bet. I like people to short stocks which I want to buy.

 

I bought the options at $120 which were $3.60 vs. $2 which Ericopoly paid for the $140s. I sold about 1/3 after 20 fold gains and 1/3 about 40 fold then exercised the rest at expiry. I was only willing to risk about 20% of my portfolio on a leveraged bet. The $140s looked too risky to me at the time. I expected a 20% to 40% share price rise which caused the option pricing to offer an extremely attractive risk/reward. The huge and rapid rise in the share price was not expected by me and I attribute that to the genius of Prem and his team.

 

I agree.  Due to the high short interest and difficulty to borrow, the premiums on put options were through the roof.  We were selling put options for huge premiums (I think we were getting more than $6 for the $60 puts, but I can't find my spreedsheet), and reinvested about half the proceeds into call options.  I don't recall having a lot of confidence that the calls ($130-$160 strike) would pay off, but thought it was worth the gamble due to the huge short interest (equal to the float at 4.2 million shares) and improving situation at the company.  I think we sold most of our calls for a 10-20X gain, but really didn't plan on such a windfall.  (I also was proudly wearing my tinfoil hat at the time and believed that SEC enforcement of Reg SHO could cause a massive short squeeze.  We had all of our shares in certificate form at the time so they couldn't be borrowed).

 

I think there was some luck involved in these huge gains that many on this board shared in (and yes, I also have this board to thank for getting comfortable with the investment although I was just lurking on the old MSM board at the time) due to the fact that there were no hurricanes that year.  At the time it seemed like there would be hurricanes, although now it seems obvious that there wouldn't be.  This investment seems like a no-brainer now, but at the time there had been a lot of negative surprises in the recent past.

 

I think selling the puts was really the great opportunity there - free money under almost any circumstance.  Buying the calls was more fortuitous than anything for me and I would have never done it if I wasn't selling the puts along with buying stock.

 

I have been looking for a similar investment opportunity ever since, as I'm sure many on this board have been.  I think the basic situation is best described as:

 

1) a large short interest where the shorts fundamentally don't understand the company (i.e. the shorts legitamately thought FFH was cooking the books and was insolvent)

 

2) an actual dramatic improvement in fundamentals, but just as importantly in transparency.  They stabilized run-off, cancelled the finite re-insurance contract with Swiss Re, restated past financials and got a clean bill of health from the auditors (not that they needed it), shored up the balance sheet by selling their Asian equities (in a very timely sale!), lowered re-insurance recoverable (and hedged the rest in the genesis of the huge CDS trade)

 

I have a company in mind currently that I think satisfies both conditions, but would love to hear of other companies that board members think fit this bill.  I think a company like RIMM probably satisfies the first condition, but not the second.

 

Thank you for your account.  Would appreciate info about the company that satisfies both conditions.  Thank you.