Thursday, January 1, 2009

Goldman Sachs Pair Trade: Long and Short

Due to the credit crisis, the investment banking model is broken. Current stand alone investment banks are racing against the clock to find reliable funding source for their outsized portfolios. That being said, investment banks are voracious capitalist market makers with tremendously talented people. Goldman Sachs, the highest class of the bunch, has produced many powerful government officials and has led the world in financial innovation and ability to make profits facilitating markets.

What is an investor to do?

Recently Warren Buffett, at a pivotal time for GS, invested $5B in perpetual preferred shares of Goldman Sachs yielding 10% at par. If I were to read the tea leaves of why Warren Buffett made this investment, I would say Warren believes that despite all of the problems that Goldman Sachs has, it's track record as a profit machine will attract a white knight. Thus even if the credit crisis were to continue relentlessly and deplete all on hand resources for GS, at some point prior to any default event, a buyer will take the company private, making all preferred shareholders whole in the process.

What examples do I have for this thesis? Think about Warren Buffett and Salomon Brothers. That position started with an initial investment in preferred shares of the investment bank also. Second, look at the arrangement that PIMCO holds with Allianz as an independent subsidiary of Allianz insurance conglomerate. PIMCO has no liquidity problems despite having just as many leveraged positions.

This being said, no one can predict when the white knight will appear. In the process, Goldman could lose another 25%, or 50% or even 75% or more of it's stock price prior to being rescued. The common stock holds the greatest risk in this case, even though all classes of securities in the capital structure would suffer greatly.

Thus the position proposed is the following:

Long - Goldman Sachs A Series - Non-Cumulative Preferred Securities - Floating Rate
Short - Goldman Sachs - JAN 10 $55 put contract
(Or if you do not use options then short GS common shares directly at above $84/share)

Buy 1 put contract for every 100 preferred shares purchased
(Or short 100 shares of common for every 100 shares of preferred purchased)

Any investor should "leg" into this position. Buy puts at below $9 and buy the A series at $9/share or below.


Dr.W. Berglund said...

When a corporation makes money solely from money (we have returned to the betting and borrowing to bet of pre-1929)and an economy has a banking system that is no longer designed and regulated to serve the people through the promotion of commerce you have what is called Reaganomics. We can design a building, we can design a bridge and we can design professional spectator sports. We can design a U.S. and a world economy that would wipe out hungry and poverty ,but the greedy people may have to get a real job.

The government is responsible for building and maintaining an infrastructure to promote commerce. The U.S. hasn't done anything since 1960. When will the next water main break. Ride a bus? Eco friendly toilets? Clean Water? Grey Water?Eco buildings?

The U.S. has a bunch of corporate front groups(nonprofit weasles) that live in the halls of congress that Lobby to get a big slice of the taxpayer pie and also to create a funnel to collect as much consumer money as well, while we exploit our military and foreign aid in order to steal the natural resources of other countries(Operation Ajax 1953).
Dr. W. David Berglund
P.S. Lets face some people whore themselves at the expense of the many. GMO corn=high fructose corn syrup=a fat ass diabetic America via corporate farm subsidies...YEA

Lockstep said...

On March 9th, 2009, the preferred shares reached 8.94 intraday. The purchase of the shares would have occurred at $9. It is now trading at $20.20.

At the same time, I would have purchased the JAN 10 $55 put at $9, which would have expired worthless on Jan 20th. Next time I should pay closer attention to my positions.

Thank goodness I still made money.

Lockstep said...

I will sell my GS-A preferred shares today at $20.20.


Goldman sachs could be the most corrupt company in the world.