Better Options for Ackman's Investment in Target

Source: Hedgeye.com

There are two main reasons why this investment did not work out for Ackman and his investors: overleverage and bad timing. This article--a follow-up to a previous posting--discusses these root cause elements and suggests a way that Ackman could have used options to better effect in his investment in Target.

Overleverage

The research I did to write the YCharts Focus Report onTarget convinced me that the retailer does indeed have some deep problems related to its culture and management style. Ackman, as an activist investor, invests in companies that have value-destructive faults, so it is no wonder that he was drawn to Target.

The position of an activist investor is sort of like that of a house flipper, except in the latter case, the house is not actively attempting to thwart the owner’s attempts at rehabbing it!

What is Intelligent Option Investing?

Intelligent Option Investing consists of:

1. Rationally assessing the value of a stock.
2. Seeing clearly what the option market is forecasting for the stock's price.
3. Using a sensible combination of stocks, options, and cash to tilt the risk / reward odds in your favor when a stock's value deviates from its price as forecast  by the option market.

Institutional Option Investing Case Study: Bill Ackman’s Calls on Target

Executive Summary

• Even though Ackman’s investment in Target was unsuccessful, the option portion of the trade is well-documented, and an analysis of the structure of this investment is instructive.
• This article analyzes Ackman’s use of the “listed look-alike” option market and how institutional option transactions are structured and traded.
• We find Ackman’s use of In-the-Money (ITM) options to be an intelligent, measured approach and discuss why, in general ITM options should be a go-to strategy for stock investors.
• We find that a combination of overleverage and poor timing lay at the root of Ackman’s losses in Target, and discuss what might have been done better.

Ackman’s Options

While researching the most recent YCharts Focus Report onTarget, I started to get interested in Pershing Square founder Bill Ackman’s ill-fated investment in the company—especially in the substantial option let of it. Derided as “speculative” by Target’s management and taken as an example in the media of how “dangerous” options can be, I was expecting something entirely different from what I found.

While Ackman’s investment in Target investment was not successful, the example holds some valuable lessons for intelligent option investors, especially those of you looking at using options in an institutional context. Unlike Ackman’s Herbalife put options, for which we had little hard data,[1] information regarding his call options on Target are well documented in an SEC form 13-D.[2]