By: Costas Bocelli — May 25, 2016
How to Turn Wall Street’s Shady Business into Your Gain
If Donald Trump wins the White House, he plans on building a huge wall across thesouthern border with Mexico.
But he should also turn his sights on the Chinese Wall in southern Manhattan, because it’s in need of serious repair.
If you’re wondering what the heck a Chinese Wall is, it’s a business term describing an information barrier within an organization that’s erected to prevent exchanges of information or communication that could lead to conflicts of interest.
Take Goldman Sachs for example.
It’s one of the largest and most profitable investment banks in the world.
And it has its hands in a lot of cookie jars.
The company operates in four segments, but the “vampire squid” is a ubiquitous creature on Wall Street.
Merger & acquisitions, securities underwriting, market making, sales trading, research analysis… you name a financial service, and Goldman Sachs plays some kind of role in it.
So you can see why it’s vital to isolate these groups and keep the information separate as to ensure nothing improper takes place.
That’s how it’s supposed to work.
But if you believe that, then I’ve got beach front property to sell you in Arizona.
There’s little doubt that Goldman Sachs takes compliance very seriously, and the company employee handbook on ethics and information sharing is probably thicker than a phone book.
However, in the real world of high finance, the Chinese Wall resembles something that looks more like a block of Swiss cheese.
And it’s been that way for a very long time.
You see, I’ve witnessed it first hand as a market maker in the options trading pits when I was a on the floor of the Philly Exchange from 1998 to 2004.
And the suspicious activities continue to this day.
Take the recent developments surrounding Tesla Motors (Symbol: TSLA).
Something is rotten in the state of Wall Street
Above is a one-month daily price chart in TSLA using the Candlestick style.
Notice how poorly the shares were trading between May 11 and May 18. Every time the stock tried to advance during the trading day, it was met with motivated sellers.
This can be seen by the long upper “wick,” which tells us that supply was stronger than demand, pushing the stock price well off the intraday highs.
Now in a vacuum, there’s really nothing unusual about this because it simply suggests the stock was trading with poor relative strength during the span of several trading sessions.
No big deal.
But when you add some context to the analysis, the price action appears to be a bit more odious.
You see, on Wednesday, May 18 there was news in TSLA.
Before the market opened, the Goldman Sachs analyst that covers Tesla upgraded the stock from Neutral to Buy and raised the price target to $250 per share or 22% higher from where the stock had closed on the prior day.
Analysts often change ratings and price targets in the coverage universe. That’s important part of their job.
And the stock initially had a positive reaction to the upgrade by trading higher in the premarket and during the first 30 minutes after the opening bell. But just like the previous five sessions, the buyers failed to maintain the highs as the motivated sellers leaned heavy on the stock.
But again, it’s no reason to organize a Bernie Sanders “Town Hall” meeting just because the stock didn’t have a positive reaction to an analyst upgrade from one of the most influential research firms on Wall Street.
Now here’s where things get interesting.
You see, soon after the closing bell, Tesla had some breaking news.
The company announced a $1.4 billion secondary stock offering to help finance the production ramp-up of the new Model 3 electric car.
That’s what you call a dilutive action taken by management because more stock is being issued. You can debate whether or not the funds that are going to be raised will increase the rate of revenue growth and earnings in the quarters or years to come. But on that day, the news hit the stock like a punch it never saw coming.
And guess which investment bank was named the lead underwriter on the deal?
It’s none other than Goldman Sachs!
So for most of the investment world it was breaking news.
But not for Goldman Sachs, because their investment bankers have been diligently working on the equity offering.
So let’s get this straight.
The price action in TSLA had been heavy, as motivated sellers were in control.
The stock gets an upgrade and a price target hike by Goldman Sachs hours before…
Tesla announces a $1.4 billion secondary offering and that Goldman Sachs is running the deal.
Coincidence? Or has the Chinese Wall sprung a leak?
How about calling in the US Attorney for the Southern District of New York?
Well here’s the thing…
As individual investors, there’s nothing we can really do about all the shenanigans of how business is being conducted on Wall Street.
Let’s leave that to the regulators, lawmakers, prosecutors and politicians to sort out.
But it is in our best interest to use all the available information in the marketplace and try to profit from it.
So today, I’m going to share with you another trading opportunity that could generate a 37% return over the next three weeks.
And yes, it involves Tesla Motors (Symbol: TSLA).
I’m going to open up my playbook and recommend a premium collection options strategy called a vertical spread.
The strategy involves selling one option at one strike price while simultaneously purchasing another option at a different strike price. Both options are of the same type (Calls or Puts) and carry the same expiration date.
With TSLA recently trading $220.00 per share, the TSLA June 230/235 Bear Call Spread could be sold for $1.35 credit or $135 per spread. That’s your maximum gain on the trade.
And as long as the stock price of TSLA is below 230 per share on expiration, June 17 you’ll realize the entire premium collected from the sale of the spread.
However, should the stock price rise above 235 on expiration, the spread will realize its maximum loss of 3.65 or $365 per spread.
Now you may think since the risk is roughly 2.5 times the reward potential that it doesn’t seem like a good trade. And to be sure, it won’t be if the stock trades 6% or higher in about three weeks.
Though the risk is higher, the probability of success is greatly enhanced.
You see, the trade will be profitable in 3 out 4 possible scenarios come expiration:
- If the stock trades down, you win
- If the stock trades sideways, you win
- Even if the stock trades higher but stays below $230 (You have 10 points of cushion), you win
- But if the stock trades to $231.35 (that’s the break even at expiration) or higher, you’ll lose. But your losses are capped because of the strategy and structure of the trade.
Now that the TSLA news is out of the way and the stock has been diluted, it may very well wallow around until the catalyst -- next earnings release -- which is far beyond the expiration of the trade recommendation.
And that will be just fine.
Until next week,