Perhaps you saw the headlines a few weeks ago…
You may be acquainted with Michael Burry even if the name isn’t recognizable. He was played by Christian Bale in The Big Short. His bet against the U.S. housing market leading up to the Great Recession may be the most famous trade of all time. The media loves turning his positions into news because the name Michael Burry has such far-reaching cachet. So when Burry files his quarterly report showing his funds’ holdings and there is a new short position, the media goes apoplectic. SHORT! SHOOOORT! BURRY IS SHORT! They churn out scary looking headlines intimating the inevitability of any short bearing Burry’s imprimatur. Always long on fear and short on details.
These sorts of headlines appear after halfwitted journalists peruse famous investor’s 13F filings. The 13F is a filing mandated on a quarterly basis by all asset managers managing in excess of $100,000,000. They are due within 45 days of the end of each fiscal quarter and show the manager’s positions as of the last day of the fiscal quarter. You will notice the above headlines appeared mid-August – which is about 45 days after the conclusion of the second fiscal quarter of 2023. Investors like Burry and many others trade in and out of positions constantly – so any information gleaned from a 13F filling is typically about 45 days old. Burry’s short positions could have been closed over a month before his 13F filing went public for all any of us knows.
Perhaps it’s a stretch to expect a financial journalist to spend three minutes acquiring additional context for an article, but if one had, they would have discovered Burry’s firm manages $237,971,170 as of Scion Asset Management’s most recent ADV filing.[i] So how did Burry manage to make a $1,600,000,000 bet against the market when he manages roughly 1/7th that amount of money? An explanation of betting against an asset is in order…
Let’s say there is a stock trading at $100/share. Suppose I’m an investor with a bearish view on the company, and I think I can profit by betting against it. There are two primary methods I can utilize, the first of which is selling the asset short. I can borrow a share of the stock presently trading at $100 and immediately sell it for $100. Now I have $100 in my pocket along with an obligation to return that share of stock to the party from whom I borrowed it. Suppose it drops to $90. Then I can repurchase it for $90, deliver it to the lender, and pocket a $10 profit for my trouble and market insight.* Shorting an asset is quite risky – the upside is limited to the original price of the stock (if it drops to $0, I make $100 on the trade, but it can’t drop beyond $0 – my potential profits are capped at $100), while my downside is theoretically unlimited – there is no potential ceiling for a stock price. Short selling can get you into big trouble – what if the price rises to $500? That works out to a loss of400%. That feels like a mathematical impossibility, but it is not. Short selling is risky business.
The second way I can bet against a security involves far less risk: buying a put option. A put option is a derivative security that gives the contract owner the right to sell the underlying security at a predetermined (“strike”) price before the option expires. Back to that stock trading at $100/share. Rather than taking on the theoretically unlimited risk of selling the stock short, I can buy a put option with a set strike price and expiration date for a fraction of the price of the stock itself. Suppose I buy a put option for $1 with a strike price of $95 and an expiration of 12/31/2023. This gives me the option to sell the underlying security (the stock I’m betting against) for $95 any time before the end of the year. As the current market price of the stock is $100 and the strike price of my option is $95, my option is “out of the money” (why sell the stock for $95 via the option contract when I can simply sell it in the open market for $100?). But if the price of the stock falls to $90, my option is now “in the money.” I can exercise my put option and sell the $90 stock for $95, collecting a $5 gross profit. Subtract the $1 premium paid for the option, and my net profit is $4. One other detail – options contracts always deal in 100 shares of the underlying stock. So in the example above, I’m buying one put option to sell 100 shares of the stock in question for $95/share for a $100 premium. If the stock falls to $90 and I exercise the option, my profit is $400 ($500 gross profit - $100 premium).
One upside to taking a short position via a put option is the ability to make a bearish bet with far less risk. If I’m selling a $100 stock short, my maximum downside is unlimited. If I buy a put option, my maximum downside is capped at the price I paid for the option – if the put option is never in the money by expiration, I never exercise it and all I lose is the premium paid for the option.
As you have probably guessed by now, Burry’s trade generating all the headlines was executed using put options. His maximum downside if his bet turns against him is only the premium he paid for the put options (which is undisclosed in 13F filings). But there is one other notable wrinkle the headlines (and in most cases, the entire articles) leave out – options in 13F filings are quoted in notional values.
The notional value of an option is the current market value of the underlying asset multiplied by the number of units of the asset the option controls. For example, the ETF tracking the S&P 500 index (ticker symbol SPY) that Michael Burry bought the aforementioned put options on closed at 444.85 on September 7th.[ii] Let’s say I think the market will fall about 10% to 400. As of this writing, the market price for a put option on SPY (the “underlying asset”) with a strike price of 420 expiring 12/15/2023 is $515.[iii] I only spend $515 on a bearish bet but the notional value is the current price of the underlying asset ($444.85) multiplied by the number of units involved in the contract (100 – remember one options contract always controls 100 shares) = $44,485. If I’m proven correct and the market falls 10% before the 12/15 expiration, I can buy 100 shares of SPY on the open market for $40,000 and sell them at the strike price of $420/share for $42,000, yielding a gross profit of $2,000. Subtract the $515 premium paid for a net profit of $1,485. Did I just make a $44,485 bet against the stock market? It sure doesn’t feel like it. I put $515 on the line by purchasing the put option, and I profited $1,485. But the notional value of my position was a whopping $44,485.
So Michael Burry made a $1.6 billion dollar bet against the stock market in the same way I made a $44,485 bet in the preceding example. Yes, it’s a bet against the market. But not nearly as big a bet as it appears. Additionally, what was the expiration date of the options Burry purchased? Or the strike price? How much premium did he pay? Is the position still open? No one knows. We only know the notional value, and notional values are massive relative to the actual dollar amount an investor puts at risk.
Also, while Burry did make an incredible bet against housing in 2008, his track record overall is… not great? He has an affinity for tweeting cryptic bearish statements and sending retail investors into a furor. Charlie Bilello put together this wonderful chart showing the content of a few of Burry’s tweets and the subsequent 6-month return of the S&P 500:[iv]
Following Burry’s advice made one a lot of money in 2008 but not much since then…
I will also point out there are quite a few asset managers publishing quarterly 13F filings, most of which show all sorts bullish positions. But journalists never write about these filings. You only see the headlines when some famous investor takes a bearish position. Financial journalists love beating their readers over the head with selection bias.
We always enjoy an opportunity to skewer financial journalists, but we hope this post also serves as a reminder that what other investors are doing has nothing to do with what you ought to be doing. You have your own objectives and time horizon. If you’re seeking to build wealth over the coming decades, why care what someone is doing who is willing to take outsized risks trying to turn a quick profit this quarter? Morgan Housel wisely observed most financial debates are people with different time horizons talking over each other.
Sean Cawley, CFP®
*I would really pocket less than $10, as I would have to pay interest in my margin account on the value of the borrowed share(s) while the position was open.
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This commentary reflects the personal opinions, viewpoints, and analyses of Resolute Wealth Management. It does not necessarily represent those of RFG Advisory, clients, or employees. This commentary should be regarded as a description of advisory services provided by Resolute Wealth Management or RFG Advisory, or performance returns of any client. The views reflected in the commentary are subject to change at any time without notice.
[ii] YCharts, SPY, 09/07/2023.