AMC ENTERTAINMENT: Keeps On Giving
Before the court rules otherwise.
We call her Amcyra, ready to lactate.
When a fire alarm in the courtroom adds to the branding.
Bankruptcy vs equity convergence: A race against insanity.
Have a great weekend, and stay safe in your straddle.
1. Driving Forces
At the risk of repeating ourselves and being labelled as an unserious venture that favours meme plays over serious investments, picture the following scene:
On your favourite farm, amid a rustic charm, Amcyra, the beauty queen of cattle, stands out. With her vanilla and cocoa colours and her plump udders, she gets all the attention of retail tourists and is therefore known for the freshest and creamiest milk. The rest of the herd, neglected and fed on corn, can't compete.
Thirsty, you are faced with a choice: should you appease the resentful masses by milking a less attractive cow, or should you return to glorious Amcyra to be wowed as usual?
That’s what we thought. We keep milking that AMC cow and stick with the cream of the crop.
1.1 Delaware's Heated Court Hearing
Yesterday, the court hearing on the plan to convert AMC preferred stock (APE) into common stock (AMC) began with drama when a fire alarm abruptly interrupted the proceedings. So far, everything on brand.
The two-day hearing in Delaware aims to resolve shareholder objections to a settlement that would allow AMC to reverse stock split and issue new shares more effectively.
The hearing continues as we type with shareholder objections, followed by responses from defendants’ advocates. Deputy Chancellor and Judge Morgan Zurn will announce her decision in writing sometime after the adjournment. A recommendation from the court's special counsel indicates that a decision favouring the settlement is likely.
The timing of a written decision may vary, but we expect a conclusion within one or two weeks. We believe the court has had sufficient time to consider the evidence and legal arguments since the April 27, 2023, preliminary injunction hearing.
1.2 AMC: Converging with APE or Filing for Bankruptcy
AMC is also running out of time. The company needs to raise cash as quickly as possible by issuing new shares into the market, which is currently only possible to a limited extent by selling lower-priced and more illiquid APE shares.
2. Background Information
2.1 Recap Situation
AMC was raising funds to finance loss-making operations by selling new common shares but hit the limit of authorized issuance.
A shareholder vote to increase share issuance was blocked.
To circumvent this, AMC issued a new class of preferred shares called APE as a split/dividend to common shareholders, which were not limited by authorized issuance.
APE and AMC shares were supposed to trade at a similar price, but APE is trading significantly lower due to the ongoing issuance of new APE shares.
The company plans to consolidate the share classes and increase the common share issuance to raise more funds at a higher share price.
2.2 Notes on Court Case
AMC management has proposed a more than $100 million settlement in response to opposition from a pension fund and meme stock investors.
The opposition claims the company revoked its promise not to convert preferred equity units (APEs) into common AMC stock.
Management also issued a block of APE shares to hedge fund Antara Capital, prompting disagreement ahead of a critical investor vote about the APE/AMC conversion and the 1:10 reverse stock split.
Although most common stockholders who voted on the APE conversion plan are in favour, many retail investors oppose it because of general dilution fears.
The AMC attorney urges the court to approve the deal. Everyone will lose if AMC can't recapitalize by converting the APE units into common stock.
3. Trade Execution
We express our idea by selling a risk-defined straddle, where we also sell an in-the-money call at 3, which is very likely to be assigned. If your broker cannot assign individual in-the-money calls and closes the remaining straddle all at once, this setup is not useful, and a pure put version via the butterfly is more practical. However, the risk-reward profile of the butterfly is only 1:1 and has a much narrower profit zone, making it considerably less attractive.
The risk-defined straddle has a risk-return profile of 1:7. If we get assigned every day for the next two weeks and factor in a conservative cost per assignment of 0.02, we would still be significantly better off than a pure put-butterfly construct. If no court resolution emerges over the next couple of weeks, while AMC continues to squeeze higher, it would be prudent to cut losses and re-enter at a more opportune time.
We are selling a bearish risk-defined straddle at 3.00, with wings at 1.00 and 5.00, with Aug 18, 2023, maturity. Break-evens are at 1.25 and 4.75.
3.1 Trade Entry - Jun 30, 2023
The options chains are liquid, but the bid and ask spread is wider than usual, so we were filled slightly below the mid-price level.
Total: 1.76 Credit.
3.2 Trade Risks
Price: AMC and APE share prices will likely settle at around 3 following a potentially favourable court ruling, which does not mean that an upward price squeeze during or in anticipation of a ruling is impossible.
In addition, many option positions, especially butterfly constructs on the put side, long-only puts, or short calls, will want to be unwound. AMC short sellers will buy back their positions following a 25% decline, APE shareholders will sell following a 50% increase, and AMC management may want to begin dilution immediately to raise fresh money.
Plenty of forces acting on price.
Volatility: Implied volatility is again close to its 52-week highs, but we are talking meme, i.e. anything is possible, so the risk of a further increase in volatility is high.
Assignment: The assignment risk of the in-the-money 3 call is very high when the share price is trading at 4 or above. The short interest is 25%, and the borrowing cost for short selling ranges between 200% and 300%.
4. Expected Value & Conviction
The expected value (EV) indicates the expected profit (or loss) if you make the same trade indefinitely.
Expected Value = (Probability of Profit * Expected Profit) - (Probablity of Loss * Expected Loss)
We aim for a positive EV after careful macro, micro and technical analysis, generating the edge through proactive trade management and market probability probing.
4.1 Expected Value For Risk-Defined Straddle
The maximum profit is 175; we are talking approximations. The average profit at maturity is 90. The maximum loss is -25; we have increased this value to -40 for possible assignment costs.
For MacroDozer Conviction and Early Trade Close, we believe we can realize a smaller profit with a higher probability.
4.2 MacroDozer Conviction
The market assigns a 59% probability of profit at maturity and generates a positive EV on equity of 92%.
We believe the likelihood of realizing 70% of the expected average profit with proactive trade management and early trade closure is 77%, with a positive EV on equity of 104%.
The court hearing over AMC's stock conversion plan is ongoing.
Urgency for AMC to raise cash through new at-the-market shares issuance.
Investors' opposition was countered by a proposed $100m settlement, which we expect to go through within the next two weeks.
We sold a bearish, risk-defined straddle with a risk-reward of 1:7.
Positive expected value of 104% with proactive trade management.
5. Final Chapter
Expect updates on BrainDozers within 4-6 weeks. We use the exact headline ending with (+/- xy%) and mark the cover cartoon with a red CLOζED stamp. This way, the performance is easy to track.
We do not send BrainDozer updates via email unless you specifically ask for them here. We want to keep the flow of information short and sweet. However, you can still access a free preview of all updates on MacroDozer as soon as they are released.
My name is Juri von Randow. You can find me on the top banner to the right, MacroDozing like there's no tomorrow. (Email version only.)
Feel free to pass me on. Warm regards.
All BrainDozer articles are purely educational; they are not tailored to any particular individual or portfolio and do not constitute investment advice. Let us know if you are interested in implementing any of our ideas. Perhaps we can help or point you in the right direction.