The Blubber

Part 1: “Capital Efficiency”

There’s always been a lot of buzz about Nancy Pelosi’s financial disclosures. Unusual Whales caught her most recent one:

Those trades look pretty boring to me. Blue-chip names with expiries 9+ months out? What gives? Everybody assumes she’s “2021 Trader Of The Year”, but where’s the elite trade strategies?

She’s bordering on “buy and hold” territory! I spend HOURS agonizing over my strikes, expiries, and entries, and I’m down in 2022 already!

In all seriousness, my #1 takeaway from Pelosi’s positioning is a simple reminder that options are remarkably capital efficient.

Humor me for a moment while we LIGHTLY brush up on our greeks.

Delta is the amount by which an option contract price changes based on a $1 change in the underlying (all else remaining equal). If you buy a 40 delta call option and the underlying stock goes up $2 but nothing else changes, your contract is now worth $80 more than it was worth when you bought it. ($2 x 40 delta = $80.)

If you’re me, you’re much more familiar with the OPPOSITE action – namely, when I buy a 40 delta call option and the underlying stock goes DOWN $5, my contract is now worth $200 LESS than it was worth when I bought it (ex. -$5 x 40 delta = -$200).

(I can hear the derivative math guys inhaling a deep breath to tell me that this is incorrect: that gamma changes the delta of my contract dynamically as the underlying price changes, and that IV is constantly shifting, and that theta is steadily removing extrinsic value from my contract… I wrote “humor me” at the beginning of this section. We’re keeping it simple today.)

When you buy a 40 delta call option, you’re essentially buying “exposure” to 40 shares of the underlying stock.

But how does all this translate to “capital efficiency”?

Let’s take Speaker Pelosi’s recently disclosed Salesforce ($CRM) position from a delta perspective:

1. On December 20, 2021, Speaker Pelosi bought 130 $CRM call options with a strike price of $210 with a  January 2023 expiration cycle
2. $CRM closed at $247.21 on 12/20/2021 so these contracts were deeply in the money (ITM)
3. Let's assume she paid $57 for each contract, meaning she spent $57 x 100 x 130 = $741,000 on her position in Salesforce
4. Let's also assume that the $210 call had a delta value of about 0.72 on the day she bought, meaning her "delta exposure" is 72 x 130 = 9,360 shares
   

Cool – she spent $741,000 to get the rough equivalent** of 9,360 shares of $CRM.

So why didn’t the master trader just buy 9,360 shares of Salesforce instead?

Well, the closing price of $CRM on 12/20/2021 was $247.21, so that would have cost her:

• 9,360 x $247.21 = $2,313,885.60
• Capital Efficiency: $741,000 / $2,313,885.60 = 0.32 = 32%
  

Damn! So you’re telling me that she decided to buy 9,360 shares of exposure** to $CRM for $741K instead of $2.3M? Her option position was bought at a 68% discount to shares!

**I know that they are not perfectly equivalent – her calls are steadily being drained by theta, shifts in IV on her contract can have a drastic impact on the value of the position, etc…

Don’t hate me for this, but we actually need to consider this trade’s breakeven price too. I know I 100% ignored a discussion on breakeven price, so let’s cover that now as it is vital to Pelosi’s strategy:

Premium Paid + Strike Price = Breakeven Price

$57 + $210 = $267

$267 is only 8% higher than the $CRM closing price the day she opened the position! A measly 8%!? How can she possibly make money like this!? Let’s check the math really fast.

If $CRM is trading at $267.01 or higher on 9/16/2022, the call contract can be exercised for 100 shares of the stock which can then be immediately sold at the ask price of $267.01 yielding… $1 in profit.

1. I buy the $210C, this transaction is a net debit of $5700 ($57 x 100 = $5,700)
2. On 9/16/2022, $CRM closes at $267.01
3. I exercise and buy 100 shares for $210 per share, this transaction is a net debit of $21,000 ($210 x 100 = $21,000)
4. $5,700 + $21,000 = $26,700 total net debit
   

I then immediately sell all 100 shares for $267.01, giving me $26,701 - $26,700 = $1. Not bad.

In all seriousness, though, one of the most important reasons to use options is for their capital efficiency – Pelosi is buying delta exposure at a 68% discount with an appealing breakeven price and a LONG time to be right, and that’s why this strategy can work for anyone… maybe even me :)

In Part 2, we’ll talk about “convexity” in option pricing, and how IV plus delta and gamma can work bigly in your favor if you’re right about timing and direction.

In the meantime, check out UW’s Pelosi ETF feature which was created because readers like you wondered how well Pelosi trades performed. The feature estimates real-time returns on her disclosed stock and options purchases since 2020.  
If you haven’t already, check out the Congressional Trading in 2021 report. A very detailed summary of how our Members of Congress traded stocks, options, crypto and more in 2021.

Hit me up with your thoughts or questions on this strategy at @danwagnerco on Twitter or on the Unusual Whales Discord!