Hedge fund slams Fortescue

Michael Evans April 27, 2012

PROMINENT hedge fund manager and short seller Jim Chanos has singled out Fortescue Metals as a ”value trap” stock, telling a New York conference that shares in billionaire Andrew Forrest’s company will fall ”materially”.

In a presentation to Grant’s Spring Conference, a private investment forum, this month, Mr Chanos, the boss of Kynikos Associates, told investors he feared iron ore miner Fortescue had ”a somewhat promotional management team”.

He singled out the company headed by billionaire Andrew ”Twiggy” Forrest as the global example of a ”value trap” in the ”iron ore rush”, adding that he was betting against the company.

”In our hedge fund, we are long BHP v Fortescue and others,” said Mr Chanos, according to an account of his presentation in Grant’s Interest Rate Observer, the publication of the conference organisers.

”BHP is a much more stable company. They see the cycle more than others do, they’ve been through it more than others have and it’s been an interesting hedge for those that play it that way.”

Mr Chanos was the first big US investor to expose Enron as a fraud. He also famously bet against Macquarie in 2007, saying the investment bank’s famed model could not last.

A client of mine sent the above article to me and thought it would interest me.

He was right.

It spurred me to look at FMG’s options actions.

FMG closed at $5.63 on 27 Apr 2012.

1)   CALLS. High volume has been building Thurs and Fri last week. Weekly calls traded increased by 213% whilst puts were higher by 83%. On Friday, Jun 625 calls attracted 1 large trade. The volume executed in this series alone and by just 1 broker represented about 34% of the overall calls traded on that day. This trade looked like initiated on the buy side by the broker.

However, despite the buying, this trade did not look like the opening of a bullish trade though. On observing some transactions in this series executed back in mid March, it looks this trade on Friday was more of a closing trade, taking profit by buying back calls sold in mid March, and not a opening of a long bullish trade.

2) PUTS increased as well. On the puts side, 42% of the volume for Friday was over a combo trade commonly called bear put spread. The volume was attributed to the buying of Jun 550 put combined with selling of Jun 500 put. The trader is trading a bearish view on the stock.

3)   Another indicator of interest is its volume. This huge increase of volume was similar to what we saw 5 weeks ago, week ended 23 Mar. FMG hit a high of $6.18 then and we saw similarly huge volumes. The stock fell back following that volume pattern. Last week, it looked quite similar. The stock hit a lower high of  $6.03 this time and has fallen off since then as well. The difference at the moment is that in the mid mMay peak to trough, it stopped at $5.66, this time the peak is lower and the trough seems to lower as well. On Friday the stock already closed at $5.63.

From options actions, there seems to be some pressure on the downside on the stock. The increased volume on the calls may just be masking the storm brewing in the stock.

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From ANZ (after dividend) to BHP in May

Switching Back to Resources From Finances Using Options

http://video.cnbc.com/gallery/?video=3000081392

Wednesday, 4 April 2012 1:10 PM ET Wai Yee Chen, Partner, RBS Macquarie Street Sydney says investors should be able to lock in a lower entry price for a resource stock like BHP in May, to make the switch from financials back to resources

Selling ANZ $22.51 May (European) calls (only exercisable after ex dividend in mid May)
and
Sell BHP May $34.01 put (though can not be exercised earlier, but seller can close early to take profit should BHP rises)

Holder of 2000 ANZ is able to sell 1300 BHP put options

High weekly options volume

XJO finished the week at 4335 (above 4300 after quite a few months)weekly equities volume was 8% lower but weekly options volume was more than 5 million traded.

Does that tell us anything?

Despite it being options expiry week, which normally generate around 4 million trades for the week, that was very good volume.

Let’s have a look where the volume came from.

Looking at the XJO Index options, volume was flat, not much higher than the week before. Hence it looks like volume came from trading in equity options (specific share options).

Sectors that had heavy volumes traded in calls were the banks and oils.

CBA had an increase of almost 4 times more than the week before, followed by ANZ  twice more and NAB and WBC trailing by more than 1 time more. Puts were  higher as well but not in the same proportion.

In the oil sector, STO and OSH demonstrated similar pattern.

As of Friday, the market looked like one that’s taking advantage of the strength in some sectors, by capturing some income from selling call options. But whether traders are convinced the market has broken a psychological level and moving higher from here? That’s the question I would like to answer in the coming weeks.