11/01/2020
Read in your browser
On 09/26/2020 I published a write-up on a situation I found compelling: “Mr. Market has done it again with CoreCivic”. Now, after a month, with the price overing at ~$6.30 per share, the risk-reward profile is astonishing, with upside in the hundreds of percentage points, while downside is fairly limited, or even non-existent.
While in the medium to long run the thesis is strong, in the short run CXW presents a bimodal outcome: either [A] Biden wins on Tuesday and the stock falls (a democratic win could have already be priced in but let’s assume it is not) or [B] Trump wins on Tuesday and the stock skyrockets. I found another, different way to playing the stock that represents a (quasi) arbitrage.
Let’s bet it
The long thesis is fairly simple: there will always be criminals around, under both a Biden or a Trump adm., and it is highly improbable that cash-strapped states and federal government, with other, more pressing, issues to solve, will ban the use of private correctional facilities anytime soon. And even if they do ban private prisons, by the time the government builds all the facilities needed to replace private ones, CoreCivic will have produced enough cash flow to buy itself a number of times; the stock is currently trading at a P/FFO of 2 (!).
If you’re interested, you find the whole argument, as well as risks, in the article cited above.
But, as I said, I found another way to play this thesis in the short run.
Do you know about sport betting, don’t you? Betting on the NFL, NBA, or a soccer match for my European readers. But we can also bet on the outcome of the “sport” of politics, specifically on Biden v. Trump.
What if I place a bet on Biden while buying the correct amount of call options on CXW?
First and foremost, what is the optimal expiration date for the calls? I’ve chosen “Mar 19 ‘21” calls, allowing the stock enough time to move in the desired direction even in the case of a contested election, such as Bush v. Gore in 2000. By the way, lawyers from both parties are already preparing for such an eventuality.
After that, a look at the math:
A few assumptions and clarifications:
Event [A] = Biden wins; Event [B] = Trump wins;
Odds on a Biden win at 1.50, as available here in Europe, specifically from WilliamHill;
Assumed tax rate on derivatives gain of 20.0%;
Assumed residual derivatives value in Event [A] of 20.0%;
Assumed CXW price in case of Event [B] of $20, look at the article cited above to understand form where this number comes from; keep in mind that, in 2016 after Trump v. Clinton, CXW was well north of $35 per share.
For this example, I’ve chosen the $10 strike price, representing a good balance between expected return and break even price.
As you can see, by betting $80 on a Biden win (odds at 1.50) and buying a contract of “CXW Mar 19 ‘21 $10 call” (at $.50), I can collect “free money”.
You can play around with the amount wagered on a Biden win to adjust for desired returns in Event [A] and [B].
I’ve called this a (quasi) arb. as there are two specific issues to keep in mind: [1] bad liquidity, in both the betting (limits on the amount you can wager) and the options market, and [2] the remote possibility that CXW doesn’t move upward in the case of a Trump win (highly improbable, but, with this market, you never know for sure). Don’t bet the house on it.
Thanks for reading.
Caveat emptor. Do not trust a 16 yrs. old on the internet. Do your own due diligence.