This Investment Pays Off 100:1 – The Thesis is Sound, but is the Timing Right?

by Darwin on September 16, 2011

I was watching CNBC Thursday when an interesting guest presented what may be the “Big Short” incredible play of 2011-2012.  Bill Ackman, the founder of the Pershing Square Hedge Fund presented his thesis on a currency play that will pay out at 100 to 1 if it occurs.  It’s a binary trade where he’ll lose his investment completely if it fails to come to fruition, but a 10,000% return on even a small portion of his fund’s total capital could boost him into a 3-4 digit return for investors in the next year.  Here’s the premise broken down methodically as he explained it:

  • The Hong Kong Dollar has been pegged to the US dollar for decades.  Hong Kong has altered their peg multiple times throughout their history and now is an optimal time for them to do so.
  • Political and Financial forces may push them to do so.
  • Unemployment is low, inflation is high and civil unrest may force the financial ministry to repeat prior delinking of currency and commodity pegs.  The current economic situation is untenable, so his thesis is that it is a matter of WHEN, not IF.
  • He anticipates the currency should either a) float or b) be reset at a ~30% offset and then re-pegged.
  • He has bought numerous out of the money options at VERY LOW premiums because this play has not been anticipated or attempted by any other mainstream investors.  Therefore, if the currency is allowed to appreciate, boom!
  • He has purchased both 12 month and 18 month options, the longest allowed.  Because of the combination of cheap options and his anticipated 30% move, the play will pay off at 100 to 1 or more, making it his most prolific trade ever.
  • It was interesting to hear that this was fully researched and enacted without even making a trip to Hong Kong.  He said he didn’t want to tip off the market to this trade.  The could be the Soros moment (Black Friday) of 2011.

I’ve been on the winning and losing end of multiple options trades, including complex options like shorting the US Treasury with leveraged ETF options (that’s a mouthful…and the trade’s well into the money right now by the way, even though Treasuries continue to push yields lower driving mortgage rates to 60 year lows!).


Have You Ever Enacted a Similarly Complex Trade?

Would You If You Had an Incredible Thesis and the Payoff Was Huge?


{ 23 comments… read them below or add one }

Jeff @ Sustainable Life Blog September 16, 2011 at 11:07 am

That’s quite the play – I’ve never done anything that complicated before (I consider myself to be too stupid to pull off something like that with out losing my shirt.


Darwin September 16, 2011 at 11:45 pm

I’d say you’re SMART, not stupid by avoiding losing your shirt! Most stuff like this isn’t for routine retail investors; interesting nonetheless.


Krantcents September 16, 2011 at 2:56 pm

Trading in options is a whole other type of investing. I do not feel comfortable with it at all. If I did the value of my investment must be something that I counld stand losing. Afew hundred dollars is my limit!


Darwin September 16, 2011 at 11:46 pm

I’ve been using options for years for select circumstances. I do like the various ways they can be used, but I’ve also learned a fair share of lessons using them (by losing my money).


Investor Junkie September 17, 2011 at 4:07 pm

Not all option strategies increase risk. In fact it can help decrease risk.


Darwin September 18, 2011 at 10:54 pm

Oh totally; selling covered calls, using for tax management on winning positions, etc. Plenty of ways they’re hedges, not bets.


retirebyforty September 16, 2011 at 3:05 pm

Wow, sounds a bit like gambling to me, but he probably knows what he is doing.


Darwin September 16, 2011 at 11:46 pm

He’s a pretty successful hedge fund manager. And in this case, it’s a small portion of his capital.


JT September 17, 2011 at 6:55 am

The trade makes sense. After the Chinese announced 3% appreciation for the Renminbi this year and actually followed through with it, there’s only more pressure on the HKD to follow the rise. Based on Purchasing Power Parity, it’s already undervalued.

This trade is definitely interesting. If Hong Kong goes for a 1:1 with the CNY, then that’s 20% upside in a trade not at all anticipated–20% is a lot for a pair with practically zero implied volatility. I’m sure one-touch options out 12-18 months are super cheap. Might be worth a gamble as it really is a matter of “when” and not really “if.”


JT September 17, 2011 at 7:22 am

BTW, after reading this, I opened the WSJ. Back page of the A section has a summary of the HKD peg. Basically, their view is that even with high inflation HK has allowed the peg to hold in place, no guarantee that they’ll revise it now.

Apparently the writer missed the last week of front page news. With ECB/BOJ/BOE/FED committed to US dollar delivery in Europe, what’s to say the US Dollar won’t eat most of the Eurozone’s actions to monetize sovereign debt?

This is definitely a trade I may enter on Monday. I feel bad for the poor people in risk management at FX dealers who are going to be running around like chickens with their heads cut off on Sunday at 7 EST when Asia opens. This trade obviously gathered some momentum. But hey, you put $500 on it and if you’re right you go buy a new BMW. If you miss, who cares, it’s only $500!

In the 80s it was all about the German Mark and Pound–huge FX profits were made in both. Soros and Druckenmiller broke the BOE, no reason they couldn’t come back to break the HKMA. Getting greedy on Saturday morning.


Darwin September 18, 2011 at 2:05 pm

Wow, sounds like you’ve done a lot of research on this (more than me!). Have you found the options to execute the trade?


JT September 18, 2011 at 9:31 pm

Eh, apparently he’s doing this OTC. I can’t find a single options dealer that will take the bet.

You could long the HKD against the USD at a broker like Oanda, though. Only downside is the negative carry of roughly .5% per year. With an exotic you can grab 30:1 leverage.

So, if you use 30:1 leverage, you’re looking at 6 2/3 years before the interest expense pushes you out of the trade.

If the HKD is revalued up 20%, you’re talking a 600% return.

A 3% down move–almost impossible given that it’s pegged–would wipe you out.

Six times your money doesn’t sound as interesting. You can thank the Dodd Frank bill for making retail FX leverage so low. Higher leverage (used to be 100:1 on all pairs, if not more) would make this trade way better from a crazy trade perspective.


Darwin September 18, 2011 at 10:54 pm

Very nice analysis! I should give you credit for the post :>

Moneycone September 17, 2011 at 8:27 am

His interest in retailers is what I knew about Ackman. This is very interesting! I wonder if he’ll be proved right! Time will tell.


Len Penzo September 17, 2011 at 12:56 pm

I have a friend who plays around in the currency market. He’s bold enough that I bet he’ll give this idea a run. What’s enticing here is that, assuming you agree that Ackman’s theory is sound — and you avoid the greed factor — with a potential 100:1 return, the risk/reward ratio is such that you don’t have to commit a lot (relatively speaking) of money to make it worth your while.


Darwin September 18, 2011 at 2:07 pm

Interestingly, you can also do a “risk-free” option on the Hong Kong Dollar itself without the options for the 30% upside and no downside risk. Since it’s NOT going to depreciate and only appreciate, your only risk is time value. The play may hold steady for years, but eventually pop!


cashflowmantra September 17, 2011 at 4:51 pm

Risking such a small amount of capital seems like a fairly good trade, especially if you can afford the loss. I am sure that Ackman can so it is no big deal for him. Interesting that he didn’t want to tip off the market, but now the cat is out of the bag. Wonder if that is part of the strategy?


Darwin September 18, 2011 at 2:08 pm

Yeah, I often wonder why and when hedge fund managers decide to tip off the market, especially if the disclosure wasn’t actually required by securities rules.


Sam September 17, 2011 at 7:32 pm

It could work! The best return I ever had was aroun a 60 bagger. Stock went from $3,000 to $180,000 and I sold about $163,000. I was so pumped! Ah, the good old days in the dot com boom.

If only I invested more! Lol


Darwin September 18, 2011 at 2:09 pm

That’s a nice run! I’ve had a few multi-baggers (like Apple, Baidu,etc) but I’m always too conservative to hang on to the full position and let it ride. I usually sell a bit every month or two until I’m down to a few shares and then wish I’d never sold any!


DIY Investor September 18, 2011 at 9:29 am

I’m wondering if he will cover the cost of his trade just by announcing it on CNBC. Surely, some viewers will pile in thereby driving up the price of the low premium options at which point he could sell some and be playing for free.
Nothing like going on CNBC and announcing a potential 100:1 play.


Darwin September 18, 2011 at 2:10 pm

Yeah, that’s a great point. You’d think a bunch of premium has now crept into the options and he could just sell a few off to cover his initial entry and now it’s all gravy! The beauty of first-mover advantage.


Bret @ Hope to Prosper October 2, 2011 at 10:48 pm

It’s an interesting proposition Darwin. I should put up a thousand or two with those kinds of odds.

I’ve always believed the Chinese should be pressured to float their currencies. It is economically unfair to undermine the domestic markets in other countries like this. It reminds me of the Japanese and their dumping tactics in the ’80s.


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