Tag Archives: alt-investing

Hedging A PayPal Spin-Off Arbitrage Investment Strategy

PYPL and EBAY stocks are expected to start trading in the “when-issued” market this week. Introducing four investment strategies for different levels of risk tolerance. The PayPal spin-off investment scenario reflects an expected return of 2% to 11%. The long waiting period is finally coming to an end as PayPal (Pending: PYPL ) and eBay (NASDAQ: EBAY ) are getting closer to the first spin-off milestone – July 8th, the spin-off record date. The record date has some significant meanings in this context: Holders of EBAY shares will be entitled to receive PYPL at the distribution. The first batch of (largest) shareholders will receive their distributed shares. Trading at the “when-issued” market begins based on shares distributed in the first batch. After the previous article published about the PayPal spin-off arb strategy, I received many questions about how to create an optimized position that would benefit from this spin-off arb opportunity in a hedged environment. I answered some of this questions, and I want to present some scenarios that will assist readers and potential investors to tailor the best position to meet their unique characteristics. At the beginning, I wish to address two primary issues that are fundamental to this investment strategy: risk aversion and outflow theory. Before investing in the PayPal spin-off (if investing at all), investors should know exactly what their risk appetite is. Some investors take high risks in anticipation of higher returns than usual, and other investors take small risks and expect moderate gains. Both approaches are perfectly fine, but an individual investor should think of that before engaging with a spin-off arbitrage strategy and create an investment strategy that fits his or her risk aversion preferences (institutional investors assess their risk appetite regularly). Investors looking to gain from a short-long position should accept the outflow theory that I presented in a May article . An investor who believes that both eBay and PayPal will soar after the split should engage in a different strategy, which I will not cover here, and hold both equities long. To create a trading scenario for the spin-off, I will assume that most readers will receive the distributed shares between a week after the record date and the distribution date. At this point, EBAY.wi and PYPL.wi shares already reflect a 10% price fluctuation. Let’s discuss the four possible scenarios: Scenario A: take no action during the spin-off; Scenario B: hold only long position (sell 100% EBAY); Scenario C: hold long and short positions at a 2:1 ratio (sell 50% EBAY); Scenario D: hold long and short position of the same size. I also assume that the PYPL.wi price will increase by 5% during the period I described above, 3% during the weekend between the distribution date and PYPL’s first trading day, and an additional 10% on the first trading day. All figures are within the reasonable spin-off fluctuations that were presented in the previous article. I also assume that the positive changes in PayPal’s stock price equal the adverse changes in eBay’s stock price. I calculated the return and volatility based on a distributed share price of $32 for a PayPal share and $28 for an eBay share, assuming cash from selling the EBAY stock was not reinvested. The four scenarios presented above yielded the following return and volatility figures: Scenario A B C D Return 2.1% 7.1% 9.0% 10.9% Volatility 1.05% 2.80% 3.39% 4.01% Investors highly averse to risk can choose to take action and get an estimated return of 2% of scenario A or just sell all units of the EBAY stock once received and gain 7% from a PYPL long-only position as presented in scenario B in the period between the moment the distributed shares are received until the end of the first day of trading in PYPL shares. Investors who have some tolerance for risk can choose a long-short strategy that maximizes return from the spin-off but is accompanied with a slightly higher risk. Scenario C, which suggests to sell 50% of eBay’s distributed shares and short the other 50%, offers a lower risk for investors than scenario D. Investors who are somewhere in the middle between complete risk aversion and total risk taking could choose a larger/smaller quantity of EBAY shares to sell in order to hedge PYPL fluctuations. Investors who hold options of eBay pre-distribution can add an additional hedging layer with post-distribution options and protect their positions better from any downside. However, since the outflow of cash that is expected from PYPL and EBAY will trigger a possible movement in prices, it might be easier to hedge the position by playing with the ratio between the long and short positions. Disclosure: I am/we are long EBAY. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Additional disclosure: Information provided in this article is for informational purposes only and should not be regarded as investment advice or a recommendation regarding any particular security or course of action. This information is the writer’s opinion about the companies mentioned in the article. Investors should conduct their due diligence and consult with a registered financial adviser before making any investment decision. Lior Ronen and Finro are not registered financial advisers and shall not have any liability for any damages of any kind whatsoever relating to this material. By accepting this material, you acknowledge, understand and accept the foregoing.

The PowerShares S&P 500 Low Volatility Portfolio ETF: Taming The Shrew?

An S&P tracking fund that ‘filters out’ volatile S&P issuers and tempers overall volatility. The fund has proven itself with consistent dividends and share appreciation. Incepted in May 2011, the fund has yet to be proven in a bear market. In the dialogue of ” The Taming of the Shrew” , Gremio famously asks , ” But will you woo this wild-cat? ” Gremio must have surely understood investing! You see, trying to tame portfolio volatility is like wooing a wildcat. However, as many an investor has discovered, there’s no attaining above average returns without taking higher volatility risks. According to Investopedia, “Alpha is one of five technical risk ratios; the others are beta, standard deviation, R-squared and Sharpe ratio” and that Alpha is, ” the excess return of the fund relative to the return of the benchmark index. ” Every passionate investor seeks Alpha through ” a course of learning and ingenious studies,… though time seem so adverse and means unfit .” Another technical risk ratio, ” Beta “, is the measure of volatility relative to the market. In brief, it’s a statistical relationship measuring the volatility of an asset relative to the market as a whole; i.e., to a benchmark. The benchmark is assigned a beta of 1. A beta of less than 1 means that the asset is less volatile than the market and a beta greater than 1 means that the asset is more volatile than the market. Beta is best thought of as the expected percentile change of an asset’s value relative to a benchmark change. After a little thought a prudent investor is certain to ask whether it’s possible, through careful selection of low volatility stocks, to produce above average results. In other words, can low beta produce high alpha? A passionate retail investor might even attempt to construct such a portfolio but generally speaking it would be quite a task. So it begs the question, whether there are ETF products available to satisfy this requirement. There are at least 20 volatility focused ETFs. These include those focused on the Russell 2000 and Russell 1000, S&P 500 enhanced volatility, rate-sensitive low volatility, Japanese, European, International Developed Market, Emerging Market and Global volatility focused funds. There’s one plain vanilla ETF that seems to focus simply S&P 500 low volatility. That is the PowerShares S&P 500 Low Volatility Portfolio ETF (NYSEARCA: SPLV ). According to Invesco: The PowerShares S&P 500 ® Low Volatility Portfolio is based on the S&P 500 ® Low Volatility Index… …The Index is compiled, maintained and calculated by Standard & Poor’s and consists of the 100 stocks from the S&P 500 ® Index with the lowest realized volatility over the past 12 months… The fund remains at least 90% invested at all times. Since the fund’s objective is to track low volatility, it’s a good idea to see how volatility is distributed throughout the fund. It’s said that a picture is worth a thousand words so the following table tells quite a story. The question becomes just how to describe the volatility by sector. To this end, a simplified version of beta is constructed by determining a simple average beta of the fund and it’s sectors and then comparing it with the entire S&P 500. This may be accomplished through the use of the corresponding individual Select Sector SPDR S&P ETFs. Average Beta Per Sector Sector Average Beta Consumer Discretionary 0.990 Sonsumer Staples 0.878 Financials 0.864 Health Care 0.858 Industrials 0.761 Technology* 0.670 Materials 0.893 Utilities 0.220 Energy 0.000 Average 0.682 According to Select Sector SPDR; … Each Select Sector Index is calculated using a modified “market capitalization” methodology. This formula ensures that each of the component stocks within a Select Sector Index is represented in a proportion consistent with its percentage of the total market cap of that particular index. However, all nine Select Sector SPDRs are diversified mutual funds with respect to the Internal Revenue Code. As a result, each Sector Index will be modified so that an individual security does not comprise more than 25% of the index… According to the Select Sector prospectus these are actively managed funds and are focused on tracking the entire sector regardless of volatility . It’s then becomes a simple matter to table and compare each sector’s beta. The S&P 500 is divided into 9 sectors. The fund is also divided into nine sectors but in a different way. The companies in the fund’s IT and Telecom sectors are included under the single heading of the S&P ‘technology sector’. Also, SPLV omits the energy sector completely. Hence, in order to create a 1-1 correspondence, the IT and Telecom sectors are combined and an entry of 0.00 is assigned to the energy sector. Beta Comparison Table Sector SPLV Weight SPLV Beta SPDR Beta Consumer Discretionary 6.504% 0.990 1.050 Consumer Staples 21.028% 0.878 0.610 Financials 35.413% 0.864 1.270 Health Care 11.195% 0.858 0.690 Industrials 14.083% 0.761 1.200 Technology* 6.355% 0.670 1.000 Materials 2.832% 0.893 1.290 Utilities 2.596% 0.220 0.250 Energy 0.000% 0.000 1.340 Average SPLV Beta 0.682 It is plain to see from the table that in some cases, the SPDR Sector Fund actually has a lower beta than does the SPLV sector. It is important to observe also, the Select Sector SPDR funds have far more holdings in each portfolio. For example, the SPLV financial sector includes 35 holdings and a beta of 0.864. On the other hand, the Select Sector SPDR Financial Sector fund, XLF has 88 holdings, essentially the entire S&P financial sector, with a beta of 1.27. What about SPLV’s performance when compared to the entire S&P 500? This is accomplished through the use of the SPDR S&P 500 Trust ETF (NYSEARCA: SPY ) which tracks the performance of the S&P 500. ETF Shares 1 Month YTD 1 Year 3 Year From 5-5-2011 SPY -2.17% 0.87% 5.09% 53.20% 54.86% SPLV -0.72% -2.19% 4.86% 34.53% 46.69% In the volatile month of June, SPLV did prove its mettle, losing a mere -0.72% versus a -2.17% loss for the unrestricted S&P tracking SPY. Year to date SPY was virtually unchanged with a 0.87% gain whereas the more defensive SPLV was down; -2.19%. This is more than should have been expected. Having an average 68% of the volatility of the S&P, SPLV should have returned at least a positive 0.59%. Over one year, it was nearly even with the unrestricted S&P tracking ETF. Over three years, the SPLV low volatility shares returned 34.53%, which works out to about 64.90% of the 53.20% return of the market tracking SPY shares. Hence, in the expectation ballpark. Lastly, from the inception date of May 11, 2011, SPLV outperformed its expectations with a 46.69 return vs. the unrestricted SPY’s 54.86%. Having an average of 68% of the S&P volatility, a 37.30% returned would have been expected. These are market price comparisons which do not include the $3.5381 total dividends distributed since the May 5, 2011 inception date. (click to enlarge) The question then becomes whether holding a low volatility S&P fund is worth the sacrifice of some of the upside gains vs. the unrestricted S&P 500? This is difficult to answer since SPLV came to market, as mentioned, in May of 2011 and has yet to prove itself in a real bear market. However, if the correlation of the fund to date is any indication, SPLV may well serve as an excellent ‘ defensive tool ‘ for an investor already in the market. There are many important questions the investor must consider. For example, is it worth the commission cost of reallocating? How much of the investor’s portfolio is really at risk? What will be the short or long term capital gains tax risk? Is there enough free capital at hand to ‘average down’ portfolio holdings in the event of a bear market? There are numerous good reasons to invest in the fund. For example, an investor might be too close to retirement to risk the full volatility of the equities market, but still has several years before the funds are needed, may consider it. Another is too use the fund to protect profits accumulated over the past several years and still participate in the market. It’s also important to note that the fund is marginable and that there are listed options for SPLV. Hence an experienced option investor may use SPLV as an underlying asset in combination with various options strategies. According to the summary prospectus the fund carries 100 holdings, matching the number of holdings in the S&P Low Volatility index and has 127.4 million shares outstanding adding up to a $4.742 billion market cap. However, it should be noted that the fund’s most recent P/E at 19.37% is higher than the unrestricted SPY P/E at 17.46. The fund is currently selling at a very low premium to its underlying NAV at 0.08%. SPLV has paid 43 dividends since inception totaling $3.5381 per share. That works out to 14.1978% of the fund’s closing price on its first day of trading 5/5/2011. Management fees are 0.25%. In summary, it seems that volatility can be indeed be tamed but it is done so at the expense of alpha. However, for those willing to devote themselves to a low volatility S&P fund, nested in a carefully diversified portfolio for the long term, well else can be said other than all’s well that ends well. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Additional disclosure: CFDs, spread betting and FX can result in losses exceeding your initial deposit. They are not suitable for everyone, so please ensure you understand the risks. Seek independent financial advice if necessary. Nothing in this article should be considered a personal recommendation. It does not account for your personal circumstances or appetite for risk.

Seeing The Forest Through The Trees; Timber ETFs

In the never ending search for new and interesting betas, perhaps few betas are as unique as that related to wood products. Perhaps apart from the occasional reality TV show, wood and industries related to it, aren’t the trendiest of products these days, but from snazzy car and home interiors, to humble old fashioned writing tablets and pizza boxes, wood, and its derivatives, everywhere one may look. Though the betas of wood ETFs may not be too far away from 1.0 on average ( WOOD ; 1.09, CUT ; 1.22), they may still perhaps supply a portfolio with an interesting route towards further diversification, and hence perhaps deserve a look. ________ Two of the most notable timber ETFs seem to be the surprisingly named WOOD and CUT. Though they are largely similar there seem to be certain qualities of each which make them slightly different from one another, but none the less interesting perhaps. _________ Apart from the year to date returns(price based); 1.86% for CUT, and 2.39% for WOOD, they also have different dividend based yield profiles per se, with W having a ~1.6% div. yield (according to Google finance), and C having a ~2.6 div yield. Apart from these sorts foreground, if one will, differences, the two ETFs also have different geographical allocations as far as their holdings’ are concerned. While Both have a US centric skew to their holdings, CUT seems to ultimately have a lesser percentage of its holdings invested in US based investments. One might argue that from largest to smallest position, WOOD also seems to be more concentrated(albeit slightly) in top holdings more so than CUT as well. These two ETFs share different subsector concentrations as one might expect, but before we get to that lets spice things up with an exciting picture of paper products. _______ For, though WOOD has so far held the crown in so far as skewness is concerned, CUT does show some more skewness in some regards, most specifically in so far as its subsector concentrations are concerned. For, though one may most often associate timber and wood products ETFs with a gentleman “leaping from tree to tree” in the forests of “British Columbia”, this death of the tree per se, is seemingly just the beginning of the flume ride if one will, that wood and its derivatives take through the world of industry. Image Source , Log Flume rides, soaking innocent bystanders at amusement parks since 1963 For when looking at these two wood ETFs one may notice that while WOOD is more concentrated in the paper products sector and “Reits”, presumably timber bearing land, with ~26% of said assets being held in said Reits, CUT seems to just sort of ” cut to the chase”; with a full 80 percent of its holdings specifically being in the “basic materials” subsector, presumably being wood or timberlands in general. Hence if one will it might be said that WOOD seems to be the more paper or wood derivatives centric of the 2 ETFs, with CUT being the more ” wood” centric of the two. Hence for the more specifically timber heavy play if one will, CUT might be the better ultimate choice, with WOOD being the favorite for paper products, etc. Hence perhaps the choice in between which of these two ETFs to allocate some cap., may come down to that age old discussion of wood vs. paper, and hence perhaps in a way perhaps they are, despite some broad overlap, somewhat complimentary. ______ Hence perhaps discussions of timber ETFs are also very much discussion of paper ETFs if one will. Ultimately whether one is looking for the felling of trees, or for some action regarding that semi-ancient medium of human writing etc., hopefully everyone’s investments are doing great, and everyone is having a good summer, and perhaps enjoying a log-flume ride or two, or whatever one chooses as a method to “beat the heat”. Thanks again for reading. ______ Prose of the post; an excerpt of lumberjack poetry; “spilling the fruit and chipping the bark, measuring, cutting into four by fours, and two by sixes,– numbering now instead of naming, until, even the complicitous apple was felled”