The details of my Big Bet against Krispy Kreme
 

All of these options are puts I bought. I.e. KKD is trading at around $8.82, and I need it to trade below these strike prices on these days for these options to be worth anything.

49 KKDQU ($7.50 May) bought at 35 cents, cost $1,715
50 KKDTU ($7.50 Aug) bought at 85 cents, cost $4,250
50 OKKMA ($5 Jan 07) bought at 45 cents, cost $2,250
9 OKKMZ ($2.5 Jan 07) bought at 15 cents, cost $135
20 YRDMA ($5 Jan 08) bought at $1.15, cost $2,300

Total investment (so far) around $10,500. I think I'm too heavvy in the short dated options (May & Aug) and I'm looking to add more 08's to balance things out better. As I add to my positions, I'll update this.

So there it is. If KKD turns out to be a great turnaround story under their new CEO, Brewster, you have this post as proof of what an moran I am. DesertCat blew over $10k betting against the best donuts in the world! Ha, ha! And he documented his own idiocy!

Of course, if I turn out to be right, don't expect me to keep my mouth shut. Oh yea, that's when I'll be results oriented, baby!

Re: The details of my Big Bet against Krispy Kreme
 

First of all let me say I really enjoy reading your detailed fundamental analysis of this security.

Now, with these options, your analysis can be near-absolutely perfect, and:

1. You will lose $5965 on the May06 and Aug06 options, if the likely negative price events do not occur before Aug06 expiry.

2. The long-dated options can expire worthless if the likely negative price events do not take KKD below $5 from current $9 area.

Most option purchasers buy options that are too far out the money and/or with not enough time to expiration. This is the #1 cause of loss with options. See McMillan: OPTIONS AS A STRATEGIC INVESTMENT.

Most of the time value comes out in the 3 months before expiry. This makes near-dated options very risky, especially if/when any recent volatility collapses.

Re: The details of my Big Bet against Krispy Kreme
 

Interesting. It looks like you put in 4x as much as you were originally intending? Definitely a big bet for your first options trades.

Good luck with this. I may join you depending on how the financials look and how the market reacts.

Re: The details of my Big Bet against Krispy Kreme
 

[ QUOTE ]
First of all let me say I really enjoy reading your detailed fundamental analysis of this security.

Now, with these options, your analysis can be near-absolutely perfect, and:

1. You will lose $5965 on the May06 and Aug06 options, if the likely negative price events do not occur before Aug06 expiry.

2. The long-dated options can expire worthless if the likely negative price events do not take KKD below $5 from current $9 area.

Most option purchasers buy options that are too far out the money and/or with not enough time to expiration. This is the #1 cause of loss with options. See McMillan: OPTIONS AS A STRATEGIC INVESTMENT.

Most of the time value comes out in the 3 months before expiry. This makes near-dated options very risky, especially if/when any recent volatility collapses.

[/ QUOTE ]

Your analysis seems to imply that a bet that usually is a loser is a bad bet. I guess you don't like betting on underdogs.

Re: The details of my Big Bet against Krispy Kreme
 

buying the putt with the strike price of 2.5$ seems like a waste to me. No way it loses anywehre near 70% of its value in the next year. That one seems like pure spewage to me.

Re: The details of my Big Bet against Krispy Kreme
 

[ QUOTE ]
buying the putt with the strike price of 2.5$ seems like a waste to me. No way it loses anywehre near 70% of its value in the next year. That one seems like pure spewage to me.

[/ QUOTE ]

An announcement that they are out of cash and filing a pre-pack Ch. 11 that renders the equity worthless, drops the stock below $1. That's a scenario that I think happens a fairly good percentage of the time here.

Re: The details of my Big Bet against Krispy Kreme
 

Paluka,

I like most longshot bets-- that is, bets with low win probability-- provided the win payoff is sufficient to generate long-run, better-than-marginal, positive expectation.

Since the rewards are typically estimates while the risk is typically a completely known quantity with options, I like to see a big estimated reward before I commit to said long shots.

Especially in a directional options bet.

Re: The details of my Big Bet against Krispy Kreme
 

[ QUOTE ]
49 KKDQU ($7.50 May) bought at 35 cents, cost $1,715
50 KKDTU ($7.50 Aug) bought at 85 cents, cost $4,250
50 OKKMA ($5 Jan 07) bought at 45 cents, cost $2,250
9 OKKMZ ($2.5 Jan 07) bought at 15 cents, cost $135
20 YRDMA ($5 Jan 08) bought at $1.15, cost $2,300


[/ QUOTE ]

Just to add some info for the beginners...

Best case scenario... Should KKD file for bankruptcy protection in the next 6 weeks (and trade down to let's say 50 cents)... Cat's roughly 10.6K bet is worth 100K+.

The slower burn scenario...

The May 7.50's is a bet that if/when KKD files financials by the end of this month or so, that KKD will trade down to a more realistic value... in the $5- range

The Aug 7.50's is a similar bet, but allows for presumably another quarterly financial disclosure. Notably, this is his largest bet!

The Jan 07's is a bet that the financial will continue to erode and the stock will slowly burn down, if it hasn't already filed ch 11.

The Jan 08's, Cat made the case (in the other thread) for why he believes there is a decent probability for KKD to go ch 11 in the next year or so.

Worth noting, should nothing bad happen to KKD until Jan 2008, and then they file ch 11 he will recover most of his bet (and it might be worth considering adding to the Jan 08s enough to ensure that)

I'm sure Cat will correct me if I got any of his thinking wrong.

p.s... Cat mentioned this is his first options trade... however, I'm sure this 10K is a relatively small portion of his portfolio... I do not recommend that others consider 180 options to be an appropriate number of options to trade for the first time, and you should always bear in mind the % of your equity at risk!

pps... Cat you didn't mention what your commission costs on this trade were?

Re: The details of my Big Bet against Krispy Kreme
 

Update, I bought more. Total investment around $17,000, total commissions look to be close to $400.

49 KKDQU ($7.50 May) bought at 35 cents, cost $1,715
50 KKDTU ($7.50 Aug) bought at 85 cents, cost $4,250
50 OKKMA ($5 Jan 07) bought at 45 cents, cost $2,250
100 OKKMZ ($2.5 Jan 07) bought at 15-20 cents, cost $1855
21 YRDMA ($5 Jan 08) bought at $1.15, cost $2,420
100 YRDMZ ($2.50 Jan 08) bought at 45 cents, cost $4,500

Re: The details of my Big Bet against Krispy Kreme
 

no 2+2ers buy any donuts for the next year.

edit: anybody mind explaining one of these lines a little bit, how you figured the cost and how to figure the gain and loss with different outcomes.

Re: The details of my Big Bet against Krispy Kreme
 

[ QUOTE ]
no 2+2ers buy any donuts for the next year.

edit: anybody mind explaining one of these lines a little bit, how you figured the cost and how to figure the gain and loss with different outcomes.

[/ QUOTE ]

Each option contract represents 100 shares, the cost is per share equivalent, so multiply the cost of the option by 100, then multiply by the # of contracts, to get the total cost.

Example...
100 YRDMZ ($2.50 Jan 08) bought at 45 cents, cost $4,500
100 contracts * $0.45 * 100 shares = $4,500

Re: The details of my Big Bet against Krispy Kreme
 

[ QUOTE ]
49 KKDQU ($7.50 May) bought at 35 cents, cost $1,715


[/ QUOTE ]

Thanks,
now you win the bet if the stock is below 7.50 on May 1st, or anytime before May?
How do you figure the profit if you're right?
And you lose it all if you're wrong?

Re: The details of my Big Bet against Krispy Kreme
 

[ QUOTE ]
[ QUOTE ]
49 KKDQU ($7.50 May) bought at 35 cents, cost $1,715


[/ QUOTE ]

Thanks,
now you win the bet if the stock is below 7.50 on May 1st, or anytime before May?
How do you figure the profit if you're right?
And you lose it all if you're wrong?

[/ QUOTE ]

The options expire on the 3rd friday of the month...
In the example quoted above, He paid 0.35, for the 7.50 May put, so the stock has to be below 7.15, for him to show a profit.

If on the 3rd friday of may the stock is trading at 7.50 or above, the option will expire worthless.
If the stock is trading between 7.50 and 7.15, the option will have some value, but still a loss on the trade.
If the stock is trading at 7.15, he breaks even (-commissions).
For every penny below 7.15, he makes 100 shares * 49 contracts * 0.01 = $49 profit

If the stock is trading at $5 on the 3rd friday in May...
100 shares * 49 contracts * 2.15 = $10,535 profit
and all his later dated options would also be showing a profit, as well.

Re: The details of my Big Bet against Krispy Kreme
 

Thanks for taking the time to explain that.
Interesting to say the least.

Re: The details of my Big Bet against Krispy Kreme
 

Ok, I should be done buying (for now). Total investment about $20,460, total commissions probably $400.

49 KKDQU ($7.50 May) bought at 35 cents, cost $1,715
50 KKDTU ($7.50 Aug) bought at 85 cents, cost $4,250
50 OKKMA ($5 Jan 07) bought at 45 cents, cost $2,250
100 OKKMZ ($2.5 Jan 07) bought at 15-20 cents, cost $1855
50 YRDMA ($5 Jan 08) bought at $1.15/1.20, cost $5,900
100 YRDMZ ($2.50 Jan 08) bought at 45 cents, cost $4,500

Re: The details of my Big Bet against Krispy Kreme
 

I hate to tell you this, but you're making me really hungry for Krispy Kremes... [img]/images/graemlins/smirk.gif[/img]

Re: The details of my Big Bet against Krispy Kreme
 

[ QUOTE ]
I hate to tell you this, but you're making me really hungry for Krispy Kremes... [img]/images/graemlins/smirk.gif[/img]

[/ QUOTE ]

One donut won't hurt. But only one! Don't you dare buy a whole box of donuts! One more box and they'll stay solvent for another decade...

Re: The details of my Big Bet against Krispy Kreme
 

Let's hope no one buys donuts like this:

http://www.penny-arcade.com/2006/03/01
(scroll to the bottom)

Re: The details of my Big Bet against Krispy Kreme
 

[ QUOTE ]
[ QUOTE ]
I hate to tell you this, but you're making me really hungry for Krispy Kremes... [img]/images/graemlins/smirk.gif[/img]

[/ QUOTE ]

One donut won't hurt. But only one! Don't you dare buy a whole box of donuts! One more box and they'll stay solvent for another decade...

[/ QUOTE ]

I may buy a dozen, but don't worry; I'll take full advantage of the free samples. [img]/images/graemlins/grin.gif[/img]

Re: The details of my Big Bet against Krispy Kreme
 

Link to the KKD Analysis thread

Re: The details of my Big Bet against Krispy Kreme
 

Down 3.XX% yesterday, and getting hurt some more today.

Re: The details of my Big Bet against Krispy Kreme
 

Well, you know my thoughts. So many things you can do with 20k. Putting it on an unhedged highly illiquid deep OTM put is not the first thing that comes to mind.

Also, generally, a trade should be no more than 2%-5% of your bankroll (give or take). So, I'm assuming you have $400,000-$1,000,000.

Options Makers live for people like you. [img]/images/graemlins/smile.gif[/img] GL

Your report card so far:

Risk management: F
EV scouting: B

Re: The details of my Big Bet against Krispy Kreme
 

derosnec... I disagree with your assessment... Cat's trade/investment is well reasoned, event driven, and as he's explained well within his risk parameters.

Re: The details of my Big Bet against Krispy Kreme
 

It might be within his risk parameters but there is no risk management. Options spreads are high. As soon as you buy a put (especially deep OTM puts), you get a nice big fat red number in your P&L column because of the high spread. This is tied to the liquidity issue as well. I don't see any risk management here. His trade reflects a poker mentality: find a +EV opportunity (assuming this is +EV) but totally neglect the risk management aspect.

Edit: I do truly hope it works for him - I don't mean to come across that I want to see him (or anyone) lose money.

Re: The details of my Big Bet against Krispy Kreme
 

[ QUOTE ]
It might be within his risk parameters but there is no risk management. Options spreads are high. As soon as you buy a put (especially deep OTM puts), you get a nice big fat red number in your P&L column because of the high spread. This is tied to the liquidity issue as well. I don't see any risk management here. His trade reflects a poker mentality: find a +EV opportunity (assuming this is +EV) but totally neglect the risk management aspect.

Edit: I do truly hope it works for him - I don't mean to come across that I want to see him (or anyone) lose money.

[/ QUOTE ]

you just reiterated all the reasons for not trading options, neglecting to mention any reasons to trade options. are you saying all option trades are bad? perhaps you think all options with low volume and/or wide spread are bad?

your comment on option issuers baffles me as well. options are not a scam, but you do need to know what you are doing. higher risk, but also greater reward. with great enough bankroll, this strategy is sound. are you arguing that DC's bet should have been smaller, because the likelihood of his hypothesis is slim? perhaps you can give some ballpark range to educate him (and me).

Re: The details of my Big Bet against Krispy Kreme
 

[ QUOTE ]
It might be within his risk parameters but there is no risk management. Options spreads are high. As soon as you buy a put (especially deep OTM puts), you get a nice big fat red number in your P&L column because of the high spread. This is tied to the liquidity issue as well. I don't see any risk management here.

[/ QUOTE ]

Every trade/investment made starts in the red, due to spread and commissions. Nothing unusual here.


I suggest you review his thinking and implementation of this trade/investment, and you will see risk management throughout...

1. His risk is maxed at the cost of the options

2. His Max risk is within his comfort zone of <5% of equity

3. His potential return is many times his risk

4. He has spread his risk across multiple time frames, which allows for an oportunity to reevaluate at various points in time, thus leaving open the possibility of exiting the trade at less than max risk. (It is clear that he will be reevaulating his assumptions when the financials are released)

5. The trade/invesment is event driven with at least 2 primary events (the 1st financial release and a potential bankruptcy filing at a later date... other financial releases are also events), his expectations on any one have the potential to make the whole trade/investment profitable, in the absense of any other event being correct.

6. He's also evaluated the probability of being correct


The one area he hasn't covered is what his actions would be if there was an "adverse" event, for example a buyout offer.

What else would you be looking for in the way of risk management?

Re: The details of my Big Bet against Krispy Kreme
 

He has simply made a wager on a longshot that he feels is undervalued. He paid some commissions and crossed some spreads to do this, just like you would do if you bet on a longshot to win the World Series in April. Trying to characterize these trades in any other way is pretty silly.

Re: The details of my Big Bet against Krispy Kreme
 

No I don't think options are scam at all. I trade them. His approach, however, has no risk management. Why not construct a trade with protection? It's pretty common to do.

Re: The details of my Big Bet against Krispy Kreme
 

I dont really see how you can have any protection in a trade like this.
With fairly deep out of the money options you just have to take the approach that there is a high probability of losing everything on the trade.
If you think a stock will crash why do it any other way.
Like somebody said though you should just make a trade like this is a small enough percentage of your bankroll that
a. you can repeat the trade for the next month's period (generally you have to be very patient in the stock market)
b. just make it a small enough percentage of your bankroll that is not a huge issue when it does not work out.

Yes writing options will probably yield huge profits every month. As the writers do have a field day. But it is the only way to buy stuff like this and gain the huge leverage advantage. Generally though the writers have enough backing to hedge out a trade like this by shorting the stock.
So basically if you know all this going in nothing wrong with doing the trade.
There are alot of disadvantages to straight short selling, also. So options definitely have some use in this type of trade.

Re: The details of my Big Bet against Krispy Kreme
 

[ QUOTE ]


Every trade/investment made starts in the red, due to spread and commissions. Nothing unusual here.

[/ QUOTE ]

Yes, but OTM options (especially deep OTM) are really really red (really). Example, a stock selling for $40, will have spread of a few pennies, like 40.02/39.98. An OTM option's spread however will be huge. The JAN 08 $2.50 put he bought, for example, has a .50/.35 spread. That means, immediately, his P&L is 30% in the red.

I'm busy, so no time right now to go through the rest of your thread point by point. I guess risk is not much of a concern to him (or maybe he just doesn't know the different ways of structuring a hedged options trade), so maybe the argument is moot.

Re: The details of my Big Bet against Krispy Kreme
 

John, I'll post some things he can do (probably tomorrow).

Re: The details of my Big Bet against Krispy Kreme
 

Paluka, I don't think Cat believes this is as much of a longshot as you imply.

Re: The details of my Big Bet against Krispy Kreme
 

[ QUOTE ]

49 KKDQU ($7.50 May) bought at 35 cents, cost $1,715
50 KKDTU ($7.50 Aug) bought at 85 cents, cost $4,250
50 OKKMA ($5 Jan 07) bought at 45 cents, cost $2,250
9 OKKMZ ($2.5 Jan 07) bought at 15 cents, cost $135
20 YRDMA ($5 Jan 08) bought at $1.15, cost $2,300


[/ QUOTE ]
I only have time to do the bolded option, but the only option here I would even consider is the 2nd one. Looking at the bolded option only, the stock would have to fall below $7.09 in order for buying the put options to be more profitable than shorting the stock. The last three are really just feelings, but based on this it's only even skimmed $5 for a short period over the last 2 years.

Re: The details of my Big Bet against Krispy Kreme
 

Read the analysis thread for more info on why he structured his trade this way.

Also, shorting the stock, rather than using options, would require the use of much more capital.

Re: The details of my Big Bet against Krispy Kreme
 

A few responses to todays comments

1) I don't believe in the risk reward ratio of shorting. And even if I did I doubt I could cheaply short KKD, I think the short interest and cost is very high.

2) I don't have any risk management because I don't see any way to cheaply hedge my risk. If KKD actually has enough liquidity to avoid going bankrupt, and it has a real path to profitability, it's still going to be a long time before it's even worth todays price ($700M-ish enterprise value). So the idea of buying some OTM calls doesn't seem very useful.

3) The May options expire three weeks after KKD is forced to file 2005 financials. We are going to find out a great deal, at that point, and it's likely to be bad news. KKD's trading history has no bearing on how it will trade after this news, if I'm right it's not going to "skim" $5, it's going to plunge right past it.

Re: The details of my Big Bet against Krispy Kreme
 

[ QUOTE ]
Paluka, I don't think Cat believes this is as much of a longshot as you imply.

[/ QUOTE ]

I wasn't commenting on how much of a longshot it was. I have no opinion. I just think that saying this trade is particularly risky is silly. Betting on underdogs is always risky, because you usually lose. But the rewards when you win are very high.

Re: The details of my Big Bet against Krispy Kreme
 

An update. It appears (from comments by KKD's PR person) that if KKD files financials this month, it will be for FY 2005 and previous. I believe their FY ends in January, and FY 2005 actually refers to Calendar 2004.

So this would mean they'll still be 15 months behind, and we won't be getting any details on how their lower sales have affected net margins, and how bad their financial situation is now. I expect they'll provide quarterly gross sales numbers like they did in december that will show further sales declines.

This isn't good news for my May and August options. The market for KKD stock exists now in an intersection of magical possibilities, of either a great brand turning back into a powerful growth stock, or falling into a black hole filled with losses, liabilities and lawsuits. This report seems unlikely to narrow the range of possiblities for most market participants. The calendar year 2004 financials are likely show the business was dramatically weaker than was publically reported, so that's a start. But it's iffy if that will be enough to drive the price down far enough.

I'm still holding these options until the report. I expect them to report on their available liquidity, there could be some awfully bad news there. And if they don't file on time, their excuses and a possible delisting might be all the bad news I need.

Oh, and some Kuwaitis just bought 6% of KKD. I'd love to know why. If anyone knows of any positive analysis on KKD, I'd love to read them to contrast with my thesis.

Re: The details of my Big Bet against Krispy Kreme
 

[ QUOTE ]
If anyone knows of any positive analysis on KKD, I'd love to read them to contrast with my thesis.

[/ QUOTE ]
This, my friends, is one of the identifying marks of an intelligent investor.

Re: The details of my Big Bet against Krispy Kreme
 

[ QUOTE ]
Oh, and some Kuwaitis just bought 6% of KKD. I'd love to know why. If anyone knows of any positive analysis on KKD, I'd love to read them to contrast with my thesis.

[/ QUOTE ]

International expansion?

Re: The details of my Big Bet against Krispy Kreme
 

[ QUOTE ]


International expansion?

[/ QUOTE ]

That's one possibility. I believe the Kuwaiti investors have a history of restaurant franchise investing. And supposedly UK is opening new stores (though I find that puzzling when they are also up for sale). But if KKD can tap international investors to open new stores, that provides KKD with more cash flow now, even if the new stores fail in three years.