AMC ENTERTAINMENT: Keeps On Giving (+7%)
. . . NOT!!
Executive Summary
Neither fire alarms nor general lactation could make this trade work.
The ringing has finally reached our own ears.
1. Recap Situation
We bragged and wanted to show how to catch the hottest cow. We didn't. AMC turned into a crazy cat, and we are out.
We had been firmly convinced that the Delaware court would approve the court hearing on the AMC/APE share class merger and the proposed settlement. Several favourable court and market indications have contributed to our above-average conviction.
The expected value of the trade was extraordinarily high at 104%, and the risk-return of 1:7 was worth all the chaos.
Check out the original BrainDozer article below.
2. Why Now
The immediate investment thesis surrounding the court decision on the settlement and merger of the two asset classes, AMC and APE, is now out the window. Instead of share price conversion, we got more share price divergence.
The Delaware court's rejection of the settlement has turned the case into a game of randomness and luck with no clear timeline. In such situations, stepping aside and seeking sensation elsewhere is best.
To summarize the ruling, Judge Morgan Zurn found that the settlement was unfair because it involved the waiver of specific claims to which the common shareholders (AMC) and plaintiffs, in this case, were not entitled. She also found that allocating more shares to the common shareholders (AMC) would harm the preferred shareholders (APE). Therefore, she decided that the settlement could not be approved in its current form.
AMC has been a pretty intense journey this year; we won't lie. But that's part of the game: we hold on to a thesis as long as we believe in it. If it doesn't come true within our time frame, we accept defeat and perhaps wait for it to pick up steam again later.
3. Trade Execution
The short calls, strike 3, were assigned 15 times. Sometimes only a fraction, sometimes the entire position; on average, roughly 50 per cent, 15 times.
In calculating the return on risk capital below, we conservatively assume a cost of 0.02 per assignment plus 0.01 borrowing cost for the assigned short-sold shares, which translates to an approximate average borrowing cost of 750%.
3.1 Trade Entry - Jun 30, 2023
The options chains are liquid, but the bid-ask spreads are wider than usual, so we were filled below the mid-price level.
Total: 1.76 Credit.
3.2 Trade Exit - Jul 31, 2023
We were filled at an average price of 1.50 at the upper end of the spread.
Total: 1.50 Debit.
3.3 Trade Return
The absolute return on this trade is
1.76 [credit trade entry] - (1.50 [debit trade exit] + 15 [assignments] * 50% [average assignment on position] * 0.03 [cost of reversals plus short sale borrowing])
→ 1.76 - (1.50 + 0.225) = 0.035
At trade entry, the risk at maturity was 0.24. We add the additional cost of each assignment reversal plus short sale borrowing, resulting in a total risk capital of 0.24 + 0.225 = 0.465, which leads to a return on equity of
0.035 / 0.465 = 7.5%
These are rough estimates; the trade did not perform as we expected, making it a neutral venture with significant opportunity costs in terms of mental bandwidth and other potentially missed opportunities. Nevertheless, we have once again gained new insights and learned valuable lessons.
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.