How do you get your money out of a position so big that selling it on the market would tank the share price? Now how do you do that when the company’s shares are expected to tank along with the rest of the dot.com sector? Investors lost a total of $5 trillion in the dot com crash and Jeff Bezos himself lost $9.8 billion with the poke of a needle. Unlike Jeff Bezos, Mark Cuban – the world’s luckiest man – devised a way to save his first billion dollars despite a share lock up agreement and the impending crash of the dot.com bubble.
Now called “one of the most remarkable options trades in financial history”, Mark Cuban’s trading strategy not only saved him from the dot.com bubble crash but was the first step on his path to becoming the billionaire investor we know today.
But before we get into the details of this trade, let’s quickly go back to 1989 – the year the World Wide Web launched. This innovation quickly caught investors’ attention after the launch of successful companies like Priceline, Adobe, and IBM. Their success contributed to the zeitgeist of the time and led venture capitalists to start betting big on internet startups and cashing in their profits at IPO.
Retail investors started jumping on board too, and pretty soon stocks were performing better than others simply by adding a “.com” to their name. This led to classics like PizzaNet, the Space Jam website, FogCam, and Hampster Dance – all wonderful websites in their own way but probably not successful as public companies.
Broadcast.com
Around the start of the dot.com craze in 1995, Mark Cuban – an avid basketball fan- co-founded Broadcast.com, or AudioNet as it was called back then. An online audio streaming platform for sports games, the company proved a success and quickly shifted from audio only to streaming video. Now Broadcast – emphasis on the dot com – was truly born.
The website quickly reached 570,000 users and IPOed just 3 years later at a valuation of $1 billion. Cuban’s IPO couldn’t have had better timing, and he made out with $300 million from the deal. Maybe he knew even then that this rush of investor enthusiasm wasn’t sustainable and was pushing to IPO before it was too late.
But lucky Mark got lucky again. Just months after IPO’ing, Yahoo offered $5.7 billion for Broadcast.com – more than quadrupling the website’s initial value. In exchange for his shares, Mark was given $1.4 billion worth of Yahoo shares.
Yahoo Deal
By this time Mark knew the days of overvalued internet companies were numbered. He was probably itching to get his $1.4 billion out as soon as possible since cracks in the market were already beginning to appear. Analysts who had initially believed internet companies were undervalued had begun changing their tone and the Fed’s decision to begin raising interest rates meant that by late 1999 the writing was already on the wall.
As a trader, Cuban had seen industries rise and fall on the stock market and he was not about to risk his fortune by holding Yahoo over the long term. The trouble was that part of the Yahoo deal included a 6 month moratorium on his 14.6 million shares. Because Cuban wasn’t able to sell his shares immediately, he ran the risk of becoming one of the thousands who lost their fortunes in the dot.com bubble.
As a hedge, Cuban bought puts on an internet index which Yahoo was less than 5% of during the moratorium period. Unfortunately, Cuban was too early and lost the entire $20 million he invested in puts – but his thesis was still valid. Instead of risking his entire $1.4 billion fortune hoping that Yahoo’s run would continue, Cuban was willing to take losses that would ensure he’d still make money if his Yahoo position declined.
By the end of the moratorium, Yahoo’s stock was still in great shape but Cuban was finally able to use his Yahoo shares as part of his hedging strategy. Assisted by Goldman Sachs, Cuban decided that a zero cost collar options strategy was the best way to protect his fortune against the expected downturn.
Zero Cost Collar Strategy
This strategy is well known among options traders because it helps minimize their losses on a trade. Essentially, the options collar strategy creates a ceiling and floor for the trade capping both the profit and the losses possible. This is done by buying an OTM put and selling an OTM call with the same expiration date. The zero cost collar strategy is named as such because the premium from selling the call is intended to pay the premium for purchasing the put.
Typically, traders will use this strategy to protect their long position after the underlying stock has run up quite a bit. They may believe that the stock will continue running or are not ready to sell their position yet so they take the precaution of limiting their losses in case the underlying asset turns south. Choosing an option that is very far OTM will lower the premium which is one way options traders can minimize the cost associated with buying the put.
Over the next three years, Cuban kept selling covered calls to buy puts on Yahoo stock. For each put contract Cuban assigned a strike of $85 and sold a call contract with a strike of $205. This meant that the maximum loss he would take was the $85 strike price but the most he could profit was $205. In total, he traded 146,000 contracts for calls and 146,000 contracts for puts with expirations three years out.
At first, it looked like Cuban’s strategy had failed since on January 3rd Yahoo’s stock price skyrocketed to a pre-split price of $475 per share at the height of the dot.com bubble. Because his calls were sold with a strike of only $205, Cuban was losing out on the extra profit. But the dot.com bubble soon burst and Yahoo stock fell to a pre-split price of $8.11 on September 26th 2001. Cuban’s puts printed throughout the dot.com bubble crash and thanks to his strategy, Cuban got out with most of the $1.4 billion from his Broadcast.com deal.
In the aftermath, Yahoo lost $115 billion of its market cap between 1999 and 2002. Fifteen years later, Yahoo continued to struggle as it failed to compete with other internet companies, like Google. Verizon ended up buying Yahoo in 2017 for $4.5 billion, $1.2 billion less than what Yahoo paid almost two decades before to buy Broadcast.com. Meanwhile, the Nasdaq lost 80% of its value over 2.5 years and took another 13 years to recover from the hit.
As for Mark Cuban, he immediately went back to basketball and invested $280 million in the Dallas Mavericks. Since the dot.com crash, investors have looked back on this trade calling it “one of the best ten options trades in history” or a “genius trade”. While the zero cost collar strategy itself is not remarkable, Cuban’s insight into the stock market and his ability to get out of such a large position despite a share lockup during one of the worst crashes in history was undoubtedly impressive.
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