Short Journal

October 24, 2015

Introductory Thoughts

Shorting is not currently part of the 17 Mile strategy; nor is the use of options. However, as my general ‘circle of competence’ grows over time, I eventually plan to add these tools to the strategy. Regarding options, I just do not have a good ‘feel’ for them, and I am not entirely sure I ever will, as I have spent a significant amount of time with them over the years. However, it may become necessary over time once I am managing significant sums – specifically, I envision using them for broad market hedging and entering positions quickly (i.e. selling deep ITM puts). Managing small amounts is a huge advantage for acting quickly, and at higher AUM this would no longer be available. My hope is to at least somewhat offset this loss with the use of options.

Regarding single-name shorts (or ‘alpha’ shorts, as HFMLarryBird refers to them), I believe I am far closer to folding them into my current strategy than options. For better or worse part of my ‘edge’ as a portfolio manager is my ‘feel’ for the tape and ability to loosely hold strong opinions, both of which are critically important for managing short positions…at least from my past experience and vast observations of extremely sharp money managers via Twitter over the past 12 to 18 months.

These thoughts are coming together now because of the carnage I have witnessed over the last 3 to 6 months. Of course hindsight is always 20-20, but there was a tremendous number of ‘lay-up’ short opportunities over this time that I missed out on due to my exclusion of a single-name ‘short’ strategy. For now, I will keep my short strategy to a dedicated portfolio as I develop and hone my abilities, and track the Trades and Performance as I do with the current 17 Mile portfolio. I hope to have the portfolio up and running here by month end so that performance tracking can begin by the beginning of November. Ideally I would wait to have a portfolio fully up and running by year-end, but I have more than enough ideas for a portfolio at present, and there is no better teacher than managing live positions…

Some Beginning Principles

  1. Do not bother with frauds – ‘return on invested brain damage’ does not appear worth it
  2. Ideal short candidate appears ‘cheap’ – i.e. a ‘value trap’ – typically in a declining industry, at least cyclically but ideally secularly (commodities)
  3. Be careful when shorting ‘innovators’ on valuation. AMZN, NFLX, etc. can be highly profitable, but need to watch price action closely – i.e. response to earnings calls, investor sentiment, etc. – and make sure not a take-out candidate
    • For example, AMZN was up big on the last earnings call, but faded throughout the day…not good at this valuation, IMO
  4. ‘Timing’ is always the key to a short, so price action needs to be strongly considered when initiating and managing a short portfolio
  5. Look for high hedge fund concentration in names breaking down – of course i.e. VRX…
  6. Sounds unsophisticated, but keep an eye out for idiocy such as Paulson & Co. developing a healthcare-dedicated fund
  7. Look for over-leveraged spin-outs
  8. Look to short ‘pops’ on activist involvement
  9. Scour for names currently under activist involvement
  10. Position sizing
    • Minimum: 5% at initiation
    • Maximum: 20% at initiation
  11. Portfolio exposure
    • Short book: 100% maximum gross at initiation
    • Market hedge (SPY): 100% maximum gross at initiation
  12. Benchmark: 15% absolute per annum
    • Not sure what to think about a benchmark here for a dedicated short portfolio. I want to treat this portfolio as if it was bolted onto the current 17M portfolio – so it needs to be absolute return…I want 15% per annum, which I think is doable if the portfolio is actively traded enough (i.e. you don’t ‘short and hold’ a short portfolio)