Saturday, February 22, 2014

Perils of the short trade

I was so confident that FEYE was overvalued that the short trade that I described in my earlier post seemed like a no-brainer. Funny thing that I still stand by my valuation of FEYE from the earlier post, but the fact remains that it was a losing trade. So what happened? Why did my years first trade take a bite out of my 2014 returns, which I will have to work hard to overcome for the rest of the year if I have a chance in hell of meeting or beating the market.

Lets review:

1. The quarter report for FEYE was inline with the expectations that were known to me as I got into the trade. For a high flyer like FEYE, that would mean a disappointment and should have taken down the stock. Not surprisingly it did, and it took a 12% hit post earnings.
2. The day before the earnings the stock was hovering around 72$, when it was hit by a upgrade from Wells that took the stock up 8%. This was a killer because the downside risk of the stock was padded due to this run up before the earning and though the stock took a 11% hit after the earnings, it was not enough to get me back to 65 for a break even on my trade.
3. The momentum on the stock was so powerful that the stock got right back above 70$ and stayed there for the rest of the time.
4. The volumes were not that strong post earnings, a sign that there was no conviction on the upside but there was no body going after it.
5. The ultimate sign of momentum was that FEYE even announced a 10% dilution and the stock simply shrugged it off.

So in summary everything about the valuation seemed spot on, except I did not have time on my side. The market overall went the wrong way as I was expecting it to trend lower further pressuring high filers like FEYE, but instead the market showed tremendous resilience. And even though I still think that the market is going to swoon sometime from here to May, I did not have that luxury with my trade that ended yesterday.

So lesson learnt. Never bet against a momentum stock on the short side, if you do not have time on your side. Always assume that the market has staying power longer than you and so unless your time horizon is infinite, you need to bail out of a trade if the immediate result of your trigger is not strongly biased towards your calculations. For example, FEYE hit 67$ the day after the report. This had my option trading at almost 7$ and I should have got out since my calculations did not pan out and the stock was no where near 60$ as predicted. Given the momentum the stock had to the upside, I should have sold immediately and walked away. Instead I held on and never got a chance again to get out as the stock roared back and then treaded water.

Now I need to be careful. After taking this hit I have lost some of my flexibility to risk my portfolio for 2014 as I do not want to underperform the market under any circumstance. So risk if off for now... and a lesson is well learnt.
 

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