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In this edition of the Alpha Letter, we cover:
Options: AMC is squeezing. Here’s what the option flow looks like
Momentum: Alibaba is in play
Crypto: Is the bull case for Bitcoin still strong?
Macro Economics: Inflation is coming
Stock Idea: Taking a second bite from the apple
Stocks & Options
We noticed unusual option activity in AMC on Tuesday, thanks to the Options Matrix (check it out here). Option buying was massively bullish in the couple of days before AMC shot up. It’s gained 37% over the last five trading days, and 25% on Thursday alone.
What’s next for AMC?
Option activity on Thursday looked promising. Call premium was about 2.5x put premium (same for volume in terms of the number of contracts traded).
Here’s a visual representation of Thursday’s AMC option activity below. Each bubble corresponds to one specific option contract. A green bubble means the activity was mostly bullish and a red bubble means the activity was bearish.
Visually we can see that the vast majority of AMC options saw bullish activity, but four of the options contracts saw bearish activity. Those four could definitely be red because of a couple of traders making large bets against AMC.
Two of those four expire in September, while another expires next year. The fourth one is the June 18th, 2021 expiry.
It makes sense that some people would be making longer-term bearish bets on AMC. After the hype from the ongoing rally dies down, there is a chance that AMC is unable to turn a profit in a post-pandemic world.
The bull case for AMC right now is mostly predicated on the fear of missing out on another short squeeze. Short interest is relatively high, so WallStreetBets and Twitter are abuzz about another potential short squeeze.
In this case, there may not actually be a short squeeze happening; just the hype about a possible short squeeze can be enough to drive up buying activity among people wanting to take advantage of a rip upwards.
Want to check out other momentum stocks?
I used the “Roaring Kitty” discovery scan to find other momentum stocks worth looking at. Here’s what the scan tells me:
One name that’s showing up a lot is Alibaba (BABA). A large amount of Alibaba calls were trading at large volumes Thursday after the company gapped down at the open. It looks like swing traders are counting on a sharp rebound.
See the unusual option activity below. Alibaba fills up almost the entire first page of results:
Elon Musk single handedly caused a crypto crash Wednesday when he announced that Tesla was suspending Bitcoin as an accepted form of payment for its cars. Musk cited energy consumption as the reason, but many began to speculate that it has more to do with Bitcoin not being a feasible form of payment for large corporations to accept.
What is the real reason?
If the only problem Tesla had with Bitcoin is its energy consumption, that can be fixed. Bitcoin can still be transacted using solar power electricity. The problem now is that most electricity is generated by coal.
But if the environment is really the main concern, Bitcoin can recover from this.
If it was really some other reason, Bitcoin (and other cryptos) may face an existential crisis. An S&P 500 company embracing Bitcoin was a huge step forward in crypto. Now, it may be two steps back as one of its main champions is stepping away.
If Tesla won’t accept Bitcoin as payment, what are the chances other large corporations will? Probably not great.
If Bitcoin isn’t a viable solution for payments, there are still other potential uses. One of the primary claims by Bitcoin enthusiast is that it’s a store of value. While it’s hard to prove that only after ten years of existence, that could hold some weight. Bitcoin has done much better than gold during the recent inflation worries- however, that could also be attributable to the bull market in nearly every asset class, so it’s impossible to tell right now.
The stock market fell on Wednesday afternoon after the CPI index numbers were released, suggesting there was higher than “transitory” inflation.
We have expressed our thoughts about the inflation risk in numerous posts. As a TLDR, we believe that higher inflation will lead to higher interest rates which have the potential to create massive havoc on major financial markets.
In our opinion, its not a matter of if, but a matter of when. There is just too much debt in the system that has been fueled by cheap money. Eventually, all of this debt will need to be paid off either through spending cuts, higher taxes or inflation (money printing).
Given the sheer absolute amount of debt in the system we think the only way this can ever be repaid is through inflation. The problem with inflation, is when it rises, yields fall and the interest obligation gets much larger.
Currently the U.S. has $27 million (AND COUNTING!) in debt. Assuming the interest payment on the $27 trillion of Federal debt is 0.07% this implies the yearly interest payment is $18.9 billion. But assuming inflation is here, investors will dump bonds, shooting yields up.
Here is a crude example of what would happen to the interest payments assuming interest rates moved up.
1% - $270 billion
2% - $540 billion
3% - $810 billion
4% - $1.08 trillion
5% - $1.35 trillion
6% - $1.62 trillion
7% - $1.89 trillion
8% - $2.16 trillion
9% - $2.43 trillion
10% - $2.70 trillion
15% - $4.05 trillion
20% - 5.40 trillion
If we go to 1980s style inflation and interest rates the interest obligation on the Federal debt alone would be over $5 trillion per year.
For this reason alone I have been accumulating physical gold. I only have 3.5% of my portfolio in physical gold but targeting at 6-8% rate in the near-term. And I’m not thinking of this gold accumulation as an investment, but more of an insurance policy. An insurance policy against the reckless monetary decisions world government have adopted. My gold position is a short against the entire system.
The end game is simple to me. The U.S. fiat currency will eventually collapse and you will want to be holding a real asset than can’t be diluted into oblivion. I choose gold as my short against the entire system.
Company X is a conservatively ran company which has consistently generated normalized EBITDA of $25 million and normalized free cash flow of $20 million.
The Company has $52 million in cash, $10 million in debt and is priced by the market at a historical low (ex-Great Recession) with an $85 million enterprise value. After quarter end cash increased to $56 million — indicating that Company X has already generated an additional $4.6 million in Q1 2021.
Despite the fall-out from COVID-19, Company X still generated $5.2 million in EBITDA for the full year and a remarkable $7.2 million in free cash flow. This will increase going into 2021 (re-read bullet point 2).
There are some “green shoots” on the horizon. Revenues were only down 9.6% in Q4 and EBITDA and free cash flow was $6.4 million and $5.1 million, respectively. I expect these positive trends to continue as 2021 progresses and individuals begin driving again.
All other public competitors (which are highly levered and burdened with debt) have recovered — if not more. Company X has been “left for dead” by the rest of Wall Street.
Reinstating the annual dividend of $1.20/share (a 5.52% yield) could be a catalyst in the near-term as Company X is likely to continue to generate meaningful free cash flow.
If free cash flow returns to a normalized $20 million/year (which I don’t see any structural reason why it won’t), at the current enterprise value of only $85 million, this represents a payback of only 4.3 years.
Company X has a war chest of over $50 million in cash. The management team has historically performed well acquiring small town radio stations. Any additional acquisition should add meaningful returns to the bottom line as corporate costs should stay flat.
The stock recently ran up from $20/share to $28 per share two days on zero news. We used the “mean reversion” to cash out of the position for a nice 40% gain. However, the stock has started to drop back down to attractive levels again. If the stock continues to drop we will take another bite from this apple. If you want to see our independent research subscribe below.