## Tuesday, January 13, 2009

### GM shorts pay 50% Annual Rate

Say you short General Motors (GM). You are selling it. You get the price in dollars in exchange for the stock you sold, currently about \$4.00. Until you buy it back you get interest on that money, usually, Libor - 50 bps or something, currently about zero. But, GM is 'hard to borrow', meaning, everyone wants to short it. The current 'rebate' (argot for the interest on short sale proceeds) is negative 50% annualized! This is a stock worth \$2.5B, that trades about \$100MM worth a day. That means you don't earn money on your proceeds, you pay. The stock would have to fall 50% over the next year for you to break even if you shorted it.

Of course it's more complicated than that, but let me give a simple example of the opportunity. GM currently trades for \$4.00. The June 2009 \$4 strike put trades around \$2.30, and the \$4 strike call at \$0.80. You can put on a June forward position in GM via options, by buying a call option, and selling the put.

Looking at Put-Call parity, we can generate the following implication. A synthetic forward position can be created by buying the call and selling the put:

Call-Put=PV(Forward-Strike)

As interest rates are near zero:

Call-Put=Forward - Strike
\$0.80-\$2.30=Forward - \$4
Forward=\$2.50

QED

Now, if you are a long term investor, why pay \$4.00 for the current GM, when you can by the June forward for \$2.50? If GM goes up to \$5 in two years, one makes 100%, the other, 25%. The dominance of the forward doesn't get much more obvious than this.

Anyone long GM who is not capturing the huge negative rebate is leaving a lot of money on the table. They must be dancing over in Staten Island, as stock loan desks are living large because I imagine many if not most GM stockholders are not capturing this. If you like GM, buy a forward via options. If you dislike GM, know that a 50% decline is baked into the current stock price via the un-labeled stock rebate.

Anonymous said...

GM stock doesn't have a year left. and you make 100% on the way down. so it's still positive ev.

Anonymous said...

Why do they care in Staten Island?
If you are talking about the back offices, those are in NJ.

Anonymous said...

That's called a synthetic long. Is GM still paying their dividend? That would erode some of it.

Anonymous said...

If you want to read more about this, you should see Lamont and Thaler's paper "Can the market add and subtract? Mispricing in tech stock carve-outs". They find examples of this phenomena in carve-out situations where the market value of the carve-out is greater than the value of the parent company pre-spin-off, creating an arbitrage situation where you would buy the parent and short the soon to be spun-off. When the carve-out becomes difficult to borrow, the option markets violate put-call parity in a way that doesn't rationally make sense, but also in a way that you can't profit from unless you're able to find shares to borrow against. It would however make sense, if you wanted to hold GM, to create synthetic stock. I'm assuming that GM is difficult to borrow right now... Thaler=awesome, check it out.

Unknown said...

funny how that turned out...