Monday, June 1, 2009

General Motors (GM) bankruptcy trade

With General Motors expected to file for bankruptcy soon, GM stock price has been in a freefall. In fact shares have hit the lowest levels since 1932, which was the year Dow Jones Industrials Average bottomed amidst the Great Depression. The stock price is also below $1, making shorting the stock almost impossible. Bankruptcy was one of the options for the major US automakers, when I analyzed the sector back in November.
According to this Bloomberg article, once the company files for bankruptcy , the US government would get $30 billion from the US federal government as well as 9.5 billion from the Canadian government. In return the US government would own 60% of the “new” General Motors once it emerges from bankruptcy, while the Canadian government would own 12%. The United Auto Workers health trust fund for retirees will end up owning 17.5 percent of the new company with warrants to purchase an additional 2.5 percent in exchange for forgiving GM the $20 billion it is owed by the Detroit automaker. Bondholders and other creditors would get a 10 percent stake in the new GM, with warrants for an additional 15 percent, in exchange for $27.1 billion unsecured debt according to Bloomberg. If successful, GM will emerge as a leaner company with a smaller work force, fewer plants and a trimmed dealership network.
Shareholders would most likely get wiped out, with their shares being worthless once GM emerges from bankruptcy.
So how can you play the GM bankruptcy and potentially make money in the process? First, If you hold GM stock, I wouldn’t hope for the company rising to $10 anytime soon, so I would consider selling. Otherwise the answer is pretty simple: play it with options.
If you buy puts on GM, and the stock does become worthless you would end up making a nice gain in the process. Options are contracts which give the right but not the obligation to buy ( call) or sell (puts) a security on a given date ( expiration date) at a given price (strike price). In GM’s scenario, a bearish investor would consider purchasing puts on the stock.
I would consider GM puts with a strike price of $1 for this trade. The June 2009 $1 puts closed at $0.60;July 2009 $1 puts closed at 0.67 , while September and December $1 puts closed at $.71 and $.75 respectively.
The far out puts such as the September and December 2009 ones are much more likely to yield any significant profits, since this leaves investors ample time for the company to go bankrupt.
This is a highly speculative trade that shouldn’t be entered with more than 0.5% of your total portfolio.

Full Disclosure: None ( But I am looking to open a position in Sep or Dec 2009 $1 puts).

Relevant Articles:

- The future for US Auto Stocks
- GM Bankruptcy Filing Will Bring Taxpayer Ownership, Less Debt
- General Motors (GM) bankruptcy trade

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