Nexen Risk Arb
“At the current time a risk arb spread in Nexen is causing me some large short term pain!” – October 27, 2012
That was the last line from my last post. Since then I continued to hold or add to one of the most volatile risk arbitrage spreads I’ve ever seen. Deals have blown up and I’m grateful, or perhaps lucky, that I haven’t been involved in a deal break. I’ll spare the details as I posted profusely on Twitter. Luckily the deal passed it’s biggest hurdle and the deal spread will converge significantly. Although the deal is not technically complete yet, it still requires CFIUS approval, I will likely be out of most of my position at that point. I do want to review some thoughts:
1) I underestimated the realized volatility of the stock. The stock initially traded quite appropriately in the month or two following the initial announcement. It was during this time that I began accumulating my position of short puts and long common. This seemed like a good idea at the time till the Petronas/Progress delay in mid October. From that point on the stock was never the same, moving over .50 or 1.00 a few times. In my current seat, I am highly sensitive to mark to market P&L and had to justify my position a number of times to the risk manager. That was not fun.
One can see from the chart there were multiple opportunities to enter at very good prices and actively trade the stock. I was reticent to do much trading, only selling common on downdrafts to manage P&L. I am sure this cost me a good sum of money. I justified holding on to the full position by asserting the Implied Probability of the deal was too low or that positive news could come out any day. I was trying to make back large losses AND making a large profit; said another way I was emotionally compromised in the position at that time.
In retrospect, the call spreads and options reflected similar odds to the underlying price. Rather then being influenced or trying to trade the common on an intraday basis, this might have been a much better structure given my environment and recommended to most people to use these to speculate on the deal closing.
2) Risk Arb deals are loaded with noise and there is always someone who knows more then you. Panics and sell offs occur in most risky deals, offering opportunities. Rather then sit for months in a position and be frustrated by daily gyrations, the stock offered a chance to get in at better prices with only about an hour of holding time. An important point to remember as I forgot this lesson after trading the MMI/GOOG deal which similarly offered opportunities.
This was a very big deal on multiple fronts and grateful for all the assistance I received during the course of the position. I risked a lot more then capital on this one and hopefully can reap the benefits shortly.