Deciphering Ackman’s Updated Valeant 13D for Pershing Square

Tonight, Bill Ackman filed an updated 13D for his position in Valeant ($VRX: no positions), disclosing what is now a 9.9% position.

If you look at the document which details the trading activity behind the updated filing, something interesting sticks out.   Ackman has several different versions of his Pershing Square fund (PS holdings, PSII, PS International), but we’ll focus on the big one:  Pershing Square L.P.  Here are the trades for today:


Strange, right?  Why is he buying and selling a big chunk of stock at a huge loss (first two lines)?  There are a few possible explanations.

1)  As I was looking at the filing, a few friends emailed me suggesting that Pershing had screwed up and bought too much stock, ending up over the 10% limit that could trigger short swing profit rules if he has to sell stock in the next 6 months.  Thus, Pershing realized their error and puked the stock.   This explanation seems odd to me, as he sold all of what he bought in common stock today, and he also ended up buying more options exposure, which took him to exactly 9.9%.

2) I did some rough calculations on the delta of his options trades (he bought an OTC 100-130 Feb 2016 call spread and sold puts to finance it)  using Jan 2016 listed options (call spread: 27 delta, put: -20 delta), and the amount of the common stock trade is almost exactly equal to my estimate of the options delta, which made me think that either:

2a) Ackman had bought common, but then realized he didn’t have the liquidity to pay for it, so he “swapped” it out into the options package instead.  This explanation seems pretty silly: he has to know how his funding looks, right?  And anyway, given that he stopped right at the 9.9% ownership threshold, it seems like this was pre-calculated.  Which brings me to what I think happened:

2b) Ackman wanted to execute the options trade, but he wasn’t happy with the price his options counterparty was charging him for the trade, given their delta risk on more than 1.5MM share of VRX which tends to whip around lately.   So he did a kind of “basis” trade.    In this kind of trade the client (Ackman – Pershing Square) essentially executes the hedge for the broker, on the client’s own terms, and the broker prices the underlying execution (in this case: the options package) off of the client’s “hedge” execution.

So Ackman goes out and buys 1.58MM VRX (in his main Pershing Square L.P. account – there are some in the other accounts as well), at an average price of 93.83.   Then, at the end of the day, he flips this stock to his OTC options counterparty (at $88.25), and gets prices on the individual options that are based on that level.  In other words, he sold the stock at a discount to where he bought it, but he made up for it by getting more favorable options prices.  If he’d sold the stock to his options counterparty at $94, he would have paid more for the call spread and received less for the put spread.  Here’s an intraday VRX chart:


Anyway, I found this to be an interesting thought exercise, and I’m open to any insights anyone else has on this.  It’s possible Pershing Square had one of two colossal screwups – not knowing their own cash limits, or not realizing they were getting over the 10% threshold – but I think the story I’ve outlined above makes more sense.

Here’s one more piece of evidence explaining how things may have gone down as I’ve described:  the 13D details also show Ackman buying a bunch of OTC Jan 95-165 call spreads while selling $60 puts on Friday (11/20/15 – this options package has an even larger delta than the one he did today: Monday 11/23/15).   When he did this trade, his options counterparty got short VRX deltas which they had to go out and cover.  Here’s a chart of VRX from Friday:


Can you see where this is going?  The counterparty had an expensive time hedging their short VRX deltas, so when Bill called back today, they jacked the price on him and he said “screw it, I’ll execute my own hedge,” negotiated a better price and hence, the basis trade….

EDIT:  @jdmce on Twitter points out “I can’t imagine any large options trade not tied…” by which he means: the broker isn’t losing money on this hedge: Ackman is.   Still, this jives with my “basis trade” theory:  Ackman didn’t like his counterparty hedging sloppy because they didn’t care about the execution price (because the options pricing was tied to the hedge execution) – so he told them he’d execute that part himself.