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PRO team - I just read the most recent PRO Catch-up Trades memo and have a couple of questions, specifically around the two shorts covered in this version: FXE and FAZ. I still don't feel comfortable with shorting shares so I'm looking at the synthetic short option.

Here are my questions:

FXE:
1. The original rec' back in 2011 was a synthetic short. The Catch-up trade today says to "sell short 1.6%". Does that mean that the synthetic short is no longer recommended?
2. If the synthetic short is still a recommendation, do you have some updated guidelines? Based on today's pricing, you could do a JAN 2019 synthetic short up to $105 for a credit.
3. Regarding allocation with the synthetic short, should this also match the 1.6% allocation? So based on a $105 strike, one contract for every $650k? Or should we use the original allocation of 3% (one contract for every $350k)?

FAZ
1. I noticed a different strike price on the bought put for the non-IRA ($20) vs. IRA ($15) recommendation. Is there a reason why I shouldn't do a modified version of the non-IRA synthetic short with a split strike: BTO $15 put and STO $20 call?
*Note: I might end up going with the stock alternative of V and FDS.

Thanks for any and all input!

Bests,
Luis
@brandstudere
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Luis,

I'm not Jeff, but I'll take a stab at answering your questions, since nobody else has thus far.

I still don't feel comfortable with shorting shares so I'm looking at the synthetic short option.

Well, if you're willing to go with a synthetic short, then you're essentially saying you're willing to short the stock, and not only that, but you're willing to short 100 shares of it (since you can't really short less than 100 shares with a synthetic short). I'd say if you're a bit squeamish about shorting it, you might be better off with the direct short but with a smaller allocation.

1. The original rec' back in 2011 was a synthetic short. The Catch-up trade today says to "sell short 1.6%". Does that mean that the synthetic short is no longer recommended?
...
3. Regarding allocation with the synthetic short, should this also match the 1.6% allocation? So based on a $105 strike, one contract for every $650k? Or should we use the original allocation of 3% (one contract for every $350k)?


No, I'd say that it probably doesn't make much difference whether you go with a synthetic short vs. a direct short in order to be in keeping with the current recommendation. But the currently-recommended allocation is 1.6%, so, as you observed, that would be 100 shares (or one contract of a synthetic long) for each $655,000 that you manage. But if you want a smaller allocation, you'd need to go with a direct short and a smaller number of shares. OR, you could set up a bearish spread (which is what I've done--and I'm currently in my third iteration of that).

FAZ
1. I noticed a different strike price on the bought put for the non-IRA ($20) vs. IRA ($15) recommendation. Is there a reason why I shouldn't do a modified version of the non-IRA synthetic short with a split strike: BTO $15 put and STO $20 call?


I think the risk here is that the put might continue to be out-of-the-money, and therefore end up worthless by expiration. I'm not saying for sure that that WILL happen, just that it might, and you'd end up with a sub-optimal experience in that case. It seems to me to be better to stick with the same strikes for a synthetic short. What I did recently in my IRA (which might not exactly be what Jeff would recommend) was to set up a synthetic short using the $15 strikes, and then I bought a $25 call to make it allowable in an IRA.

Personally, I've been in a direct short on FAZ (for a relatively small number of shares) for a long time, and this position has been very profitable for a very long time. Just take a look at a 5-year or 10-year chart of FAZ--this thing has a tendency towards declining values like nothing else I've seen. Of course, when it has an upward spike it can really jump (because it is leveraged, after all)--and that's the best time to short it.

I hope this helps,

Dan
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Hi Dan,
I've posted about getting more comfortable on FAZ over the FAZ board. Feel free to weigh in over there if you are inclined.

http://boards.fool.com/1228/trying-to-understand-faz-better-...


I really would love to hear about your experience holding this over the long haul.

One of my "concerns," I suppose it would be thoughts that bounces around in the back of my head is that we are at such a low point for the value, is it really a great time to short. Now I ask that, but I of course already executed mine.

The other thing I'm really curious about is to hear from members if they have been called to close their short or not. And any details they felt were pertinent about it.

Thank you! Sandy
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Dan - thank you for your response, very helpful.

Regarding the comment about being "comfortable shorting the stock", it was more about never having actually shorted shares so I wasn't sure how to do it - in terms of the steps required and other nuances (i.e. fee, dividend). I've done some additional reading and figured out how to do it (I have an account with IB). Now I'll be ready to follow any future short shares recommendation. Regardless, I ended up doing a syn short, which I was comfortable with.

Bests!
Luis
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Hi Sandy,

I really would love to hear about your experience holding this over the long haul.

Sorry it's taken so long for me to reply. I, too, was pretty hesitant about direct shorts at first. I dipped my toe in ever-so-slightly on FXE in my taxable account, way back in my early days at Pro (in 2013), shorting only 6 shares. Part of the reason I was so conservative was because of my fears, but really another big part of it was because most of my portfolio is contained in an IRA where I can't do a direct short at all, and so I was paying close attention to position sizing relative to just that one account. I didn't want it be a really large percentage of my taxable accounts, especially given that it was a direct short. So for FXE (other than my original 6 share position), I've always substituted a bear put spread (in my IRA), which is, of course, allowed, since it is a defined risk/reward type of position. And those positions on FXE have all been profitable.

But of course, you asked about FAZ, it sounds like, more so than FXE. As with FXE, I was pretty careful at the outset not to over-allocate to the FAZ short in my taxable account, given that I have relatively limited funds in that account, and I didn't want it skewed too heavily on a short (which seems risky, given that theoretically you could have an near-infinite loss on a short, although this generally doesn't happen). So I kept it very reasonable. I'm with TDAmeritrade, which never charges any shorting fees, but when shares are "hard to borrow", as is the case with FAZ, they often don't have any available (which make sense, given that they don't charge shorting fees). But I was able to get in for 60 shares, at $10.60 per share (NOTE: they've had TWO 4-for-1 reverse splits since then. A few months later, I wanted to short more, and found that TDA didn't have any shares to short, but I heard that Fidelity had them. I already had a taxable brokerage account there, so I just upgraded it to a margin account (which was easy) and then was able to short some shares there (I had to transfer some cash over there in order to be able to do it, since I didn't have much in that account at all). I doubled the position in terms of number of shares (they had done a 4-for-1 reverse split in the meantime, so I shorted only 15 shares, but the price had also dropped, so the total of that short was less. I kept on adding to the short as the price went up (and then down), eventually bringing the position to 80 shares (keep in mind, there was another 4-for-1 reverse split in on 10/01/15). And I think the fee at Fidelity is around 5%, which they charge monthly. But I found that even with the "hard-to-borrow" fee at Fidelity, I still made pretty decent money on it. But in May, 2014, I decided to buy-to-cover all my short shares of FAZ, thinking that I would set up a synthetic short instead (at 80 shares, I wasn't far from 100 shares). But before I got around to doing that synthetic short, I heard that TDA once again had shares available for shorting, so I just went ahead and did that (with the same position size of 80 shares).

Then they had the second 4-for-1 reverse split (at least while I've been in the position) on 10/01/15. They seem to do that periodically, when the share price gets really low (if you look at a 5-year chart you can see that there's a very strong down-trend). In early 2016, there was an upward spike in the FAZ share price, which is almost always a good time to (at least) think about shorting more shares, so I did so in my Fidelity account (just 10 shares). After a few months, the price had dropped a good bit, so I closed it out early. In hindsight, that may have been a mistake. :-) But I still have my 80-share (20 after the split) position at TDA, and it is still very, very solidly in the green. In all, I've made nearly $2,500 on FAZ (not counting my IRA position, which I'll get to next) over the last 4 years or so.

When Jeff issued the rec (recently) to short more FAZ, I decided to try to do it in my IRA. Of course, you can't do a synthetic (or direct) short in an IRA, but you actually CAN do a synthetic short IF you also buy a protective out-of-the-money call. You could think of it like buying a put and selling a bear call spread (you'll get a credit when you set up a bear call spread) to help pay for the put. I know they said you could actually just buy puts, which is true, but I tend to go out on my own once I'm sure I understand all the pros and cons. For me that means more commissions, but I rarely like to just buy puts since you're going to be buying some time value, and that acts as a barrier you have to climb just to get to profitability.

One of my "concerns," I suppose it would be thoughts that bounces around in the back of my head is that we are at such a low point for the value, is it really a great time to short. Now I ask that, but I of course already executed mine.

That is a really good question, and one that I like to consider as well. When FAZ has an upward spike, it can really spike (sometimes)! And that can make for a really good opportunity. Of course, it's hard to know what it's going to do next, but over the LONGGG haul, it seems to be MUCH more down than up. It seems that taking a really long-term view is best with this one (as with most long stock positions, which this one is, since we're "shorting a short").

I hope this helps,

Dan
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