What to do if you need money?
A publicly traded firm is in desperate need of money. However, due to it's credit rating, it is unable to obtain loans from the market.
Which of the following trades is the best for it to do?
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1 solution
Sell put and stock is taking double delta exposure. Are you sure this is the right thing to do?
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Quite the opposite. Selling put is long delta, selling stock is short delta, and so your delta exposure is flattened. Review call and put options .
We are making a synthetic play here, where we're essentially selling out of the money call options. Check out put call parity to understand why.
Of course, all of this is subject to
1. Transaction costs (which is cheaper than cut-throat interest rates)
2. Puts are not exercised/expire (which is why we sell the delta -99, long term options)
but if you sell company stock, thats going to put downward price pressure on the stock price. furthermore when the market sees the companys bad credit position(cant get loan) and selling of own stock, its going to generate cascade selling and maybe even short selling interest, further driving stock price down. this actually creates risk that the puts WILL be exercised?
well i didn't knew anything of this, i only answer the question knowing that if you take a short position in options you receive the upfront fee form the counterpart, but i guess at the end i just guess the answer :/
I don't understand what you mean by: "Sell other companies stock to the market". Does it mean: - Issuing shares (for corporate investors only) in the primary market - Selling the shares this company has of other companies in secondary markets?
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I've clarified that it is a short sell, where you don't originally own the securities. What happens is that you borrow the stock for a small "stock loan fee" (usu < 1% for established companies that are not hard to borrow), put up a margin to protect against adverse stock movements, and pay interest on the margin.
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I know what short-selling is but that's not what it said before, right? Also, I don't want to be knit-picking but shouldn't it be "companies' stock" with an apostrophe then?
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@Marek Vosicky – Right, I edited the option (that's what I meant when I said "I've clarified that it is a short sell"). The option previously didn't make much sense and was (mostly) inexecutable.
I've edited the grammar too. Thanks for helping us improve the experience for everyone :)
Is there a wiki for delta 99 and other concepts that are similar?
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There's a option greeks - delta wiki.
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Thanks! What I need to get is get all the fundamentals, what I want to do is learn quantitative finance from it's roots all the way up to each concept and build up from there as my math is not the sharpest.
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@A. Daniel – In that case, I would recommend that you work through the Math for quantitative finance course first, to firm up your mathematical concepts. After that, check out the wiki pages in Quantitative Finance , to understand how these are applied.
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@Calvin Lin – That sounds like a great strategy. Thanks!
To hedge the delta of the put you need to sell equal amount of stock anyway, but then say this is probably hard to do as a funding proposition and further destroys credibility of the company. Not a very good question or answer IMHO.
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The question references considering only the trades as listed. I agree that none of them are "great" approaches.
It is much easier to sell a synthetic delta 1 call (E.g. Market makers will be willing to buy it for essentially 0 after fees), than it is to sell just the stock. Similarly, while both might destroy the credibility of the company, the former will do so to a lesser extent. That's why it's the better approach.
Basically, when you sell something you get money, whereas when you buy something you need money. Let's analyze the various scenarios:
1) Sell own stock
This is likely hard to do if the company is unable to sell bonds to the market at a high interest rate. The company's stock price would be so low, that substantially higher amount of stock would need to be sold. Furthermore, this would adversely impact investor confidence.
2) Sell other companies stock
This is extremely risky, since we do not know what the market will be doing.
3) Sell delta -99 puts and sell stock.
The payoff position is equivalent to selling a delta 1 call, which means that it is highly unlikely to happen.
The company will be able to take the proceeds from the sale and invest in them.
4) Buy delta -99 calls and sell stock.
The payoff position is equivalent to selling a delta 1 put which means that it is highly unlikely to happen.
However, because they have to buy the call, the proceeds from this approach would be less than that of 3)