Riding the Blockchain Hype: How Longfin Hoodwinked Investors, Part 3

Riding the Blockchain Hype: How Longfin Hoodwinked Investors, Part 3

DISCLAIMER: None of the following is intended to be investment advice. Also, full disclosure, any links to Coinbase and Binance, etc., include referrals. It actually benefits you to use them because we will both get an extra $10 worth of BTC for free if you deposit at least $100 to Coinbase. Thanks in advance if you follow the links when you make your accounts - and even if you don’t, I hope you find this article useful! Remember: Always do your own research. This is not financial advice, so do not make any purchases or sales based on the opinions written on this website.

Here we are again, discussing the blockchain Longfin stock scheme and its CEO Venkat Meenavalli. If you haven’t read my first two articles on this, I suggest you start here - things will make more sense that way. To make a long story short, Longfin is a company which purported to be associated with “blockchain” technology but was arguably just riding the waves of hype whilst producing absolutely nothing of value. Now they’re in hot water with the SEC for other reasons.

When we left off, I was describing how Longfin was T-12 halted on April 6th, 2018. It was around and after this date that the really nasty article titles started rolling in:

• Bitcoin Mania Made Longfin a $6.2 Billion Company. Now Under SEC Scrutiny, Traders Can’t Get Out of It
• Once-Surging Crypto Stocks Face Delisting, End of Era
• SEC Had an Easy Time Busting a Fintech Company and Its Wizard CEO

This last one had some humorous quotes, such as:

Longfin’s founder and chief executive officer was described in its offering circular as a “financial wizard,” and it is perhaps useful to know that wizards aren’t real.

Actually, all of this would be hilarious if it wasn’t for how much money people are going to lose over it - myself included, maybe. It’s easy to imagine Venkat Meenavalli as a sort of humorous, bumbling, dopey Homer Simpson type if you forget the fact that his actions as a CEO have helped to bleed people dry of their investment money. With that said, I’d like to talk a little bit about how I’m personally invested in the outcome of this investment drama.

An Introduction to Options Trading

So, most everyone has a rough idea of how the stock market works at the lowest level. You buy a stock - “common stock” as it’s sometimes called - and you hopefully sell it later when it’s worth more. Simple, right? In this case, you have a “bullish” assumption - that is, you believe the stock’s price will go up. There’s also “shorting” - borrowing shares from your broker then selling them, hoping to later buy them at a cheaper price, thus making a profit. In this case, you have a “bearish” assumption - you’re betting that the price will go down. When you’re short, however, you’re paying interest on those borrowed shares - this means you’ve got an ongoing cost associated with holding a short position.

The above paragraph describes the basics, but things get a lot more complicated. You see, I’ve been teaching myself about this because, like many people, I’d like to be able to consistently turn a profit off the markets. Thus, I found myself on the next step: researching options trading.

Options trading is a kind of derivatives market - in these kinds of markets you’re no longer trading the actual asset itself (such as a share of, say, Google). Instead you’re trading something whose value is somehow determined by the underlying asset. When it comes to options, it’s not as complicated as it sounds - to (perhaps overly) simplify things, you’re just betting that a particular stock will reach a particular price by a certain date (the “expiry date”). You can bet in either direction - if you buy a “call,” you’re assuming the stock will meet or exceed a particular price. If you buy a “put,” you’re assuming the stock will meet or fall below a particular price. This target price is called the “strike price,” and the further above (or below, in the case of puts) the strike price, the more money you make. If the expiry date come along and the underlying stock hasn’t reached the strike price, your option “expires worthless.” This means that whatever you paid to buy the option is lost forever. Up until then, however, you can buy or sell options as you please, and their price is roughly determined by many factors such as the underlying stock’s price and volatility. Unlike holding a “short” position, having a “put” doesn’t involve paying any interest or ongoing cost - you just pay for the put itself, and the price you pay is called the “premium.”

I’m admittedly leaving out a lot of details here, but I’m trying to give a pretty high level overview to establish a basic understanding; if you are interested in this stuff and would like to learn more, I’ve found that this Mike & His White Board series is an excellent way to get a firm grasp on options.

Making the Correct Choice and Still Losing Money

So, why did I write all that? Simple: I want you to understand my own position in all this. If you read my previous articles on Longfin, you know I take a pretty dim view of this company for many good reasons. I therefore decided to buy a large number of puts on it - that is to say, I was making a rather big bet that the company would fall in value. As I mentioned in my previous article I first started doing this on April 3rd, three days before the T-12 halt.

The expiration date for most of my puts was April 20th, 2018. This was pretty soon - in retrospect, it would have been better to get a longer-dated one, but as my father has often said “hindsight is 20/20.” The strike price was only 7.5. I realize this seems low, but the implied volatility on this thing was insane - we’re talking in the 400% range.

“If the implied volatility is high, the market thinks the stock has potential for large price swings in either direction, just as low IV implies the stock will not move as much by option expiration.” - ally.com

At the time it seemed likely that I could continue buying and selling puts for a profit or, at worst, a small loss. With how rapidly the stock was swinging up and down, the 20th felt like it was an eternity away. Surely, I thought, the market would return to rationality and stabilize this thing in the single digits considering all the horrific news surrounding Longfin.

Well, as it turns out, the market didn’t get a chance to figure things out. This halt has lasted an entire week, and things aren’t looking hot for the prospect of it unhalting in the coming week. I hope I’m wrong. I hope it unhalts on Monday and the stock’s value tanks - as it should, considering the inherent worthlessness of both Venkat and his company - allowing me to sell my puts for a profit, or at least break even. Unfortunately, I have no way of knowing what is going to happen, so like many others who traded LFIN, I am stuck in the stressful situation of sitting on my hands. I do have some idea on what could happen, though.

Longfin’s Possible Future

I’d like to credit the people at /r/LongFinOptions for posting a lot of the information I used to write this section. This is a subreddit that was hastily established by people who were in my situation - holding puts (or, god forbid, calls) on Longfin. Based on various things I’ve read, here are a few things that might happen - bear in mind that many of these are not mutually exclusive, i.e., we might see a few of them happen at the same time:

1. Quick delist. This is the best scenario. Here, the NASDAQ makes the decision to quickly delist LFIN from the NASDAQ - hopefully on Monday. This means the stock would no longer trade on the actual market - instead, it would trade on something called “pink sheets” in the “OTC” (over the counter) market. This is a somewhat less regulated market where garbage stocks are generally bought and sold - you might have seen these in Wolf of Wall Street. If this happens, LFIN probably trades for under a dollar by the end of the day.
2. Slow delist. Same as a “quick delist,” only the NASDAQ takes their sweet time doing it for a variety of reasons. Options on with a 4/20 expiry date would expire as the halt goes on.
3. Bankruptcy. I haven’t mentioned this in any of these articles yet, but Longfin had a financing deal with Hudson Bay Capital Management. The general understanding is that Longfin is now in default because part of the agreement is that Longfin cannot stop trading for five trading days in a row. It would appear that Longfin is about to owe Hudson Bay fifty million dollars, and I don’t think they can pay it. Unfortunately, all of this doesn’t mean the stock becomes worth zero dollars overnight - bankruptcies take a long time. Net effect on short term put holders: nothing, although if it starts trading again, this is yet another reason people should be selling their shares.
4. Business as usual. Let’s posit that by the grace of God - or Satan, I’d guess, if I wanted to make some educated guesses about who would be in Venkat’s corner - that Longfin’s plan for compliance is accepted by the NASDAQ. The stock then trades normally on the NASDAQ again, where - assuming people have even a shred of sanity - the price gets dumped down to the single digits where it should be. This could happen quickly, or it could happen slowly. If this somehow happens, the SEC is still probably going to shut this thing down.

So, what’s really going to happen?

I don’t know, but my pet theory is that this is going to get delisted and never trade on the NASDAQ again. However, I believe that the NASDAQ bureaucracy is going to do what bureaucracies do best - handle things slowly and inefficiently. I think my 4/20 puts are therefore going to expire worthless during the continued T-12 halt, and I’m going to lose my entire premium. I’d welcome being wrong, but that’s my prediction. At this point I believe the only thing that can save me (and anyone else with 4/20 expiry options) is if the OCC (that’s the “Options Clearing Corporation”) makes some sort of helpful special announcement about what’s happening with these particular options. I’m not holding my breath.

What really gets my goat about this is that the original “sellers” of the puts will profit tremendously if it shakes out this way. “Writing” and “selling” options are aspects of options trading that I didn’t really get into the specifics of earlier - but to make a long story short, these people are going to get the entire premium if LFIN stays halted and anyone’s options expire. I should point out that it was insanely risky to sell puts on this dying stock, and if these people profit off of it primarily due to the halt, it’ll basically be a nice little present wrapped up in a bow by the SEC and NASDAQ. Does that seem particularly fair to you? Well, it doesn’t seem fair to me.

Let me be clear here: if you lose money on LFIN due to this halt, you are probably the victim of securities fraud. In my case it doesn’t matter that I was betting against LFIN - even if I thought that they were doing some incompetent things, there was no good reason for me to have believed that they could have been halted so soon, and for so long. I don’t care if you held calls, puts, the common stock, or whatever else: if you lost money on LFIN due to this halt, my personal opinion is that should either join a class action lawsuit against them or start your own lawsuit. People might even have a case against the NASDAQ itself due to their clumsy management of this situation - you could make the argument that LFIN should have never been listed in the first place. You could even make a similar argument against the Options Clearing Corporation, as the OCC’s own rules suggest that LFIN probably should not have ever had options available in the first place. With that said, I would not be too hopeful about getting much of your money back in the end. The legal system is all-too-often a meat grinder. In situations like these, the sad truth is that the lawyers tend to be the only ones that walk away with a smile on their faces.

I’d like to end on a pleasant note, but right now I just don’t have one. Here’s hoping I’m wrong and LFIN unhalts and starts trading directly into the dumpster on Monday the 16th. Good luck, everyone.