Imagine yourself a professional money manager and one of your traders came to you with the following investment: See if you can guess this trade, and would you do it? It amazing how many do.
“So I have this trade. We have got to put this on, I love it! The underlying is largely illiquid, even at the highest volume ever recorded; comparable securities only trade once every 17.6 years. We are going to put it on at 400% leverage, and just lever down over the course of trade.
I have not looked at the carrying cost of the position but I just assume they are negligible, because that makes it sound better to me. I have done zero top down analysis on the macro themes that could affect the trade. I have done zero bottom up analysis on what the security is worth based on cash flows or liquidation value.
I have however looked at comparable securities in the sector and based entirely on that I think it’s cheap. Oh and here is the best part! The value of the underlying is roughly 2.3 times our firm wide revenue so if it goes against us or we are cash strapped we will have no choice but to file for bankruptcy.”
