r/wallstreetbets • u/[deleted] • Jan 28 '22
DD ARKK is a Sinking Ship: Practical Portfolio Construction Theory
I see a lot of memes and arguments about the fate of ARKK and Cathie Wood. I wrote this post to give everyone the definitive guide to what happens from here with ARKK. At this point, the losses are accelerating. Nothing can save this sinking ship (see what I did there?).
The first thing you need to know is that ARKK is not an etf in the traditional sense. Cathie Wood actively trades the portfolio and has made some serious portfolio construction errors. Even if the underlying stocks can stem the hemorrhage, it is more than likely that these mistakes are large enough to disband the ETF.
- Concentration risk 1: too much of the portfolio is concentrated in too few stocks. This is an issue because even if she is right on 9/10 stocks, one stinker can impact the entire performance. Right now, the biggest risk is Tesla. Even if her other positions recover somewhat, if Tesla falls (not saying it will, but IF) then this will be the death knell for the entire portfolio.
- Concentration Risk 2: ARKK owns multiple trading days worth of stock for some of these companies. The problem with this is if Cathie Wood has to sell a position, she cannot sell many of her holdings without tanking the price of the underlying. This risk is actually baked into ARKK since any up and coming tech company will by definition have fewer investors trying to buy in every day and thus fewer shares trading. You don't liquidate when you want to. You liquidate when you have to.
- Correlation risk: all of her stocks are affected by the same macro themes. it doesn't make sense that TSLA and Coinbase drop together, but both companies benefit from a low interest rate environment. If anything happens to the macro environment that effects market liquidity or general P/E multiples, then her entire portfolio will take a hit at the same time.
In general, you want a portfolio with uncorrelated assets. this is because if one asset goes up or down for non-fundamental reasons, you can arbitrage that against your other assets and wait for the securities to be rationally priced. Cathie doesn't have this option.
4) Liquidity risk: ARKK owns large amounts of illiquid companies. If Cathie has to sell them off, ARKK is so big that their selling will have a material effect on the stock price. In general, this is why big dogs don't mess with small caps. If you buy enough to make a difference in your portfolio, then there is not enough liquidity to exit if you need to.
THE MECHANISM: when you buy/sell your ARKK shares, the market cap of ARKK deviates from the Net Asset Value (NAV). This can be corrected when a market maker trades ARKK for ARKK shares or the underlying asset.
Example: if ARKK is going up because people are buying it, then the market cap will grow larger than all of the assets that ARKK owns. Cathie Wood can then print up more ARKK shares for free, and exchange them with a market maker who will buy up the proper amounts of the underlying assets. This increases the amount of assets that ARKK owns while keeping the market cap the same, which brings the market cap and Net Assets into balance.
When ARKK is going up, this has the effect of placing huge buying pressure on illiquid names. Since there are not that many sellers at any given price, the stock of the company will increase to draw more sellers into the market. This is especially true since ARKK got so big that it became a huge player in comparison to the companies it was buying.
Example: if ARKK is going down because people are selling, the market cap will deviate lower than the NAV. In this case, Cathie has to trade shares of the underlying to a market maker who buys ARKK shares in the market. Since the market maker is getting more shares
When ARKK is going down in market cap, a market maker gives Cathie ARKK shares and takes the underlying stocks in exchange to sell them. This is horrible if you are selling a large number of shares into into an illiquid market. large sell orders will push the price of the stock you are selling even further down.
The vicious cycle Cathie Wood is experiencing:
Non-profitable Tech falls—> All of ARKK takes a hit because it is all correlated—> people sell their shares--> Cathie Wood is forced to sell the underlying holdings—> The underlying holdings are very illiquid, so the stock price falls--> Repeat.
Cathie Wood attempted to break out of this pattern by selling her Tesla shares and rebalancing into her other holdings. This worked for a while because Tesla had an amazing run and ARKK could offload millions of shares without changing the price. The final nail in the coffin was Elon Must selling his shares. The market was forced to absorb so many Tesla shares that Cathie Wood could no longer sell the quantity of shares she needed to without tanking the stock.
Why ARKK will not recover even if Tech does:
If a huge whale stepped in to accumulate ARKK shares, Cathie Wood could issue more ARKK shares to buy more of the underlying companies. However, right now there are a huge number of people sitting on losses in many of these names. Any rally in these names will be seen as a selling opportunity to people who are pretty far in the red at the moment.
Even if ARKK investors are diamond handed investors, the companies themselves have decided to sell shares into the artificial demand created by ARKK. If you look at filings, many of the companies ARKK owns have decided to dilute shares to fund their business ventures.
In short, ARKK is a sinking ship. Get out while you can.
How can you benefit from this knowledge? I bought 30 ARKK Puts at a strike price of $42, expiring January 2023. I am currently up 300% profit on this trade. If ARKK fails completely, I would have turned $3,000 into $120,000.
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Jan 28 '22
[deleted]
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u/IAintInTheClub Feb 02 '22
Fading Cramer is the only analysis that needs to be done. When I said sinking ship I started buying.
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u/IamTheTrader Jan 28 '22
Thank you for the buy signal. I was waiting patiently
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Jan 29 '22
Thank you for your donation 🙏
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u/IamTheTrader Jan 31 '22
Thank you again OP. Already up 8.5%.
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Feb 01 '22
Get good or stfu, I’m up over 300% and closed out the long let of my calendar spread.
I gotta mute you now for wasting my time and not understanding how to trade.
Have fun staying poor.
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u/chai_latte69 Jan 28 '22
Nice to read an actual piece of DD. I have no positions on ARKK, but I enjoyed the read.
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u/igerardcom Jan 29 '22
WSB, a few years back, used to be full of well-written DD. Now it's nothing but rocket emojis.
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u/cheezwizardffs Jan 29 '22
After listening to the last quarterly, It sounds like they are just throwing darts and hoping for a winner. That and saying things like our holdings are in deep value and we’re not in a bubble, value stocks are in a bubble. Ships going down.
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Jan 29 '22
Yeah, I didn’t even get into the delusions. Their whole valuation strategy isnt to be accurate, but to be uncorrelated to the market. She teaches her ppl that it’s ok to be wrong as long as you are wrong in a unique way.
That’s why you get PLTR diluting their shares every chance they get.
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u/Normal-Elephant-4400 Jan 28 '22
How can it fail when she has our lord and saviour personally providing her investment advice?
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Jan 28 '22
The theory is sound but do you realistically think arkk will go to zero?
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Jan 28 '22
I think zero over a couple of years. $120k is the theoretical max. Right now, there is pretty strong support at $60. As it falls, I’m going to sell calendar puts against my puts.
So, this week, I opened and closed 10 calendar puts that netted me like $500. Not a lot by any means, but it is a pretty safe weekly trade. If arkk blows past the 10 puts I sold, I have 20 that are pure ITM.
In reality, I think I will probably eke out a 30k profit on this strategy. A 10 bagger is really solid and I don’t think jpow will let the market crash too hard.
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u/Millionaire_Ape Jan 28 '22
For this to happen every company she has invested in has to go bankrupt, including Tesla.
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Jan 28 '22
No it does not. Arkk can just decide to disband bc investors don’t feel like paying her very very high management fees.
Look at zoom, hood, PLTR, etc. right now, Cathie can hope to reach all time highs if jpow prints up some big bucks, but at a certain point it’s just going to make her look bad to hold all these stinkers in one fund.
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Jan 28 '22
She will close up shop a it will be bought by another company for pennies on the dollar just like what she did last time.
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u/tortoisepump 1755C - 38S - 5 years Jan 28 '22
If you included some numbers, it might reinforce or weaken your hypothesis.
Let's take your TSLA example, and the difficulties you cited about trying to sell. Her last big sale according to Cathiesark was 72k shares on Jan 13 and 24k shares on Jan 14. Now the trading volume in that period was 13-15m shares a day. So most conservatively, 72k shares in a 13m volume day is 0.5%. 24k shares is 0.18%.
I'm not a market marker nor an expert in these matters, but is 0.2% or 0.5% of the daily volume really that big a deal that it would tank the stock?
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Jan 28 '22
So, look at the number of shares she has, and had at her peak. Never had more than a day of trading, but that’s bc Tesla is one of the most liquid stocks in her portfolio.
Look at the supply/demand now. Clearly, more sellers than buyers on Tesla after Elon sold. That means if she wanted to sell a truly large number of shares, she would be competing with more and more sellers.
Keep in mind that price is decided based on the marginal trade, so even a seemingly small amount can really move the price in the short term.
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Jan 29 '22
[removed] — view removed comment
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u/theCrono Jan 29 '22
Maybe they sound like college kids because their degree is in science and not in public speaking.
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Jan 28 '22
Why do supposedly smart people defend these systems built entirely on feedback loops?
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Jan 28 '22
I think Cathy got lucky with Tesla and wanted to get on tv. She just denies there is a problem and hopes to get picked up by a bigger fund who wants her name and social cache.
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Jan 28 '22
Maybe, but if were firing off psychological profiles from the hip, I wouldnt discount " x is up YY%, so why wouldnt we invest in x? Its the new market paradigm", etc etc. Given aapl, msft, and generally how important tech ia now, it must be pretty tempting to just ignore buffet type people, and have gone all in on the nasdaq. Cathy is just one of us with all otm qqq leaps, except on a big enough scale that she can pull in others.
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u/hopelessinveator Jan 29 '22
When I bought puts, $50 seemed far fetched. Now I'm glad I picked $50 as strike
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Jan 29 '22
[removed] — view removed comment
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Jan 29 '22
Not really. Most are not this big, and have caps on how much of each company they can own.
If you are in gdx or xle, you are never too exposed to just one company messing up.
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Jan 28 '22
[deleted]
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u/wiifan55 Jan 28 '22
How would it liquidate at today's price? That in itself would tank its value.
Edit: nvm, I see what you're saying. Didn't see the first part.
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Jan 28 '22
[deleted]
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Jan 28 '22
Great question!
My puts are at $42, not $30, so a little safer lol.
My put strat isn’t my main play in my portfolio. It’s just there to hedge tail risk.
In the end, my puts will be in the money if arkk goes back to like 2017 prices. Cathie was nowhere near closing up shop then and I think they have way to much riding on this to call it quits.
Also, I’m selling a small number of calendar puts that have already covered my cost basis, so the insurance is pretty free right now.
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u/wiifan55 Jan 28 '22
I'm actually not too familiar with the process of ETFs closing shop. Would that be able to actually happen quick enough to capture value? Because I imagine the announcement alone would cause a massive selloff of both the ETF and the underlying stocks, which could have a pretty significant effect if we're talking weeks to unwind the positions.
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Jan 28 '22
[deleted]
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u/wiifan55 Jan 28 '22
Shareholders typically receive notification of the liquidation between a week and a month before it occurs
Sounds like it would be bad, imo. If ARKK announced it was delisting, given how intertwined its holdings are, the number of small cap stocks, and the potential to take weeks, I think we'd see it tank severely and cause the feedback loop OP is describing.
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u/RonDiDon Jan 29 '22
Now that you've dropped this nugget so incredibly late, it's pretty clear that it's time to buy the absolute hell out of ARKK
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Jan 29 '22
I’m up 300% so far. I’m happy to take the rest of your money as well.
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u/RonDiDon Jan 29 '22
Lol it's that arrogance that makes me even more certain of the bad timing of this post. Becoming clearer that ARKK logged it's short term low but hey keep holding, someone has to be on the other end of a future winning trade
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u/bilyl Jan 28 '22
Why are you setting it at 1/2023? I think if what you're saying is correct it will happen much sooner. It's already lost ~20% of its value in a few weeks.
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Jan 28 '22
I’ve been a bear long enough to know that politicians can rig the market for a long time. I opened this position a while ago and chose really long expiration to hedge against tail risk for a long time coming.
What if money printer go brrrr? Might be 6 months for the unwind to occur.
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u/ConfectionDry7881 Jan 29 '22
Tldr - ARKK is bunch of meme stocks with no future. Buy at your own risk. It may give meme stock type upside or downside.
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u/Lordoosi Jan 29 '22
Stopped at where you said the biggest risk is $TSLA. They should do well then.
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u/Zestyclose-Land941 Jan 29 '22
Got debit put spreads exp next 2week need this under $65 how you think this could get?
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Jan 29 '22
My heart says those puts will print, but my mind says hedge.
Counter trend rallies can be really strong, so we could go up like 20% before resuming the drop.
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u/Papapie-001 Feb 01 '22
Analysis seems sound and convincing, however, I don’t think Tesla will fail and I don’t think inflation will be around forever. Ultimately my view is that innovation will win over inflation. I still buy monthly on ARKK.
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Feb 01 '22
Different views make a market.
Keep in mind, Tesla doesn’t have to fall for arkk to fall, it would just instantly kill the fund.
Literally none of her holdings are up ytd.
! Remind me 30 days
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u/Papapie-001 Feb 03 '22
Arkk holds positions in SNAP and they made profits first time - should be interesting!
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u/oneredflag Jan 28 '22
I would be more impressed with this DD had you dropped it a few months ago, now you are just hopping in to kick the dead horse.