True Job Insurance Means Shorting Your Own Company Part 2

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After posting True Job Insurance Means Shorting Your Own Company earlier this week I realized it raised some questions that weren’t answered in the post.

DHammy stated accurately:

I think its unlikely anyone is going to follow this advice. People just arent able to see how big that gap is between what they know and what they think they know.

In addition to not seeing the how big that gap is, some will see the concept of buying options too complicated to pursue. This all comes down to how important it is to hedge that risk. If you’ve deemed it important to have that hedge, but are overwhelmed by the financial complexity, then take it one step at a time.

  1. Open an online brokerage account. I use Ameritrade and love their user interface. It is clean and easy to understand.
  2. Have your account set up to trade options.
  3. Ask your broker to assist you with buying LEAPS. Ameritrade has many local offices and is very helpful. I once went into an office and spent 30 minutes with them learning about how to trade fixed income securities.

Matt’s comment got me thinking as well.

How about never joining a company, but creating your own and investing in it?

I should have been more clear. Shorting your own company is NOT an investment strategy. It is a hedging strategy. It is protection for the event you don’t want to happen. Only use a small amount of money you are willing to lose. Think of it like car insurance. You have coverage and hope to never use it.

Matt also brings up the self-employed angle. If you are self-employed or work for a private company, then you do not have the option of shorting your employer. What should be your hedging strategy here? I would advise buying long-term puts on a same sector ETF. If your company is in healthcare, then buy puts on something like ProShares Ultra Health Care ETF.

Before I get attacked on this point, let me invent a hypothetical situation to use as an example. Sue quits her job and decides to start her own luggage business. She pools her money and loans to start production on her product line. Then 9/11 hits. Nobody is traveling. Nobody is buying luggage. Her business is wiped out before her first sale. The undervalued unexpected event hit her hard. Had Sue purchased some long term puts on a travel related sector such as airlines, she would be much better off. And it wouldn’t have cost her much money.

5 thoughts on “True Job Insurance Means Shorting Your Own Company Part 2

  1. Jim

    This is an interesting post, but three potential issues come to mind:

    1) If you have a large percentage of your portfolio in company stock or “in the money” employee stock options this is a good plan (i.e. Enron). For small holdings or out of the money employee options this probably doesn’t make sense though. If you are “perfectly hedged” then the portfolio value never changes, so if it is small it just stays small.

    2) This is much more relevant in bear markets, since that is when many more companies fail. I don’t mean wait for a 20% drop first …more like when the 50dma crosses the 200dma on the S&P…

    3) Finally, I would check out the rules around insider trading. I honestly don’t know the rules, but it would suck to have your company go bankrupt, get a huge windfall from puts or shorts, then get sent to prison.

  2. Jim,
    #2 is 100% correct. In a growing economy, finding replacement employment is much easier.

    #3 I’m not sure about that. Maybe a sector short or having your spouse hold the options would be less risky?

    Good points.

  3. Marketman

    The advice is sound, but a little more involved to execute. Most people use discount brokers these days and although discount brokers can certainly help with the syntax of placing a leaps order but anything beyond that (picking the strike price for example) would be a recommendation, and reserved for a full service brokers with full price fees.

    Let’s take those Washington Mutual employees as an example. Your advice would have been very useful to them 10, 20, 30, or 40 points ago, and those LEAP puts would have paid handsome rewards (and more to come, if you ask me!). But going forward, the risks of riding the LEAP puts are much greater. Take for example the WM 2010 2.50 strike puts (symbol WMIMZ). They currently trade for roughly $1.40 with Washington Mutual (symbol WM) stock trading at $3.23. Just to break even on those 2010 puts, the buyer needs WM to continue tanking to at least the $1.10 level, another 60% decline from todays level. While its certainly feasible that an institution as incompetent as Washington Mutual ($1 million dollar home loans to all girl scouts with verifiable paper routes!) could continue their momentous decline, at some point the stock chart carnage can and does end. When the blood in the streets runs dry, your put options dry up with it.

    I love portfolio insurance in the form of Put options, but the time to buy them is when the stock charts are lofty, bonuses are handed out like candy, and the executives are high and fat on the mirage of future expectations. Using the car insurance analogy, you can probably convince someone to sell you insurance after the crash, but the premium you pay for that insurance will be well beyond the damage done.

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