The hedging method of investment banks is the standard Delta-Neutral Strategy.
After selling Put Option, the Delta is negative. When the stock price falls, the value of Put Option increases, and the seller's loss expands.
In order to hedge this loss, investment banks need to continuously sell Tesla Common Stock when the stock price falls, and use the profits of Common Stock Short Sellers to make up for the losses of the long position of Put Option.
Theoretically, if the hedging is done perfectly enough, Delta can always remain neutral, and investment banks can lock in Premium profits regardless of whether the stock price rises or falls.
But theory is theory, and reality is cruel.
The stock price of Tesla plummeted from 379 US Dollar on August 7 to below 300 US Dollar in early September, a drop of more than 20%.
Put Option changes from virtual value to Deep In the Money, and Delta quickly approaches -1.
The number of Common Stock that investment banks need to sell has increased exponentially, and there simply cannot be enough takers in the market.
Moreover, the large-scale Common Stock selling itself is a signal, which will further aggravate the panic in the market and promote the accelerated decline of stock prices.
This is a vicious cycle.
By early September, the combined floating losses of the Options departments of the three investment banks had exceeded 200 million US Dollar.
Although they did hedging to a certain extent, they still shouldered most of the losses themselves.
At the same time, another concern began to circulate in the market-
Era Vanguard bought Put Option, are you preparing to clear Tesla?
This fund holds nearly 10% of the shares of Tesla, more than 16 million shares.
If they start to reduce holdings of Common Stock under the protection of Put Option, Selling Pressure on the market will be unimaginable.
The analysis posts on Twitter are one after another. "Era Vanguard buying Put Option is not just a hedging, it is insuring Common Stock."
With this layer of insurance, they can sell Common Stock unscrupulously. The more the stock price falls, the more Put Option earns, and the more calmly Common Stock sells.
This is the standard 'Collar Strategy' variant - use the gains on Put Option to offset the losses on Common Stock, and then walk away calmly."
An analysis article by Bloomberg also mentioned this possibility:
"Era Vanguard is Tesla's second Major Shareholder, holding 9.88% of the shares.
If they decide to clear their positions, no buyer in the market can handle such a large amount at once.
The stock price will collapse, Short Sellers will have a party, and Tesla's financing channels will be completely blocked.
The privatization farce of Elon Musk has caused investors to lose confidence. If Era Vanguard withdraws at this time, it will be disastrous for Tesla."
These speculations have made the stock price of Tesla worse. Short Sellers people are even more unscrupulous in Add Position, and the depth of selling is getting deeper day by day.
Retail investors are also in Panic Selling - they don't care whether Era Vanguard will clear their positions, they only care about others running, so they have to run too.
When Lin Shicheng received a call from Goldman Sachs Michael Chen, New York the time was the morning of September 10.
"Lawyer Lin," Michael Chen's voice was much deeper than usual, "Can we sit down and talk?"
Lin Shicheng did not agree immediately, but asked, "What are you talking about?"
"Put Option in the hand of Era Vanguard."
Michael Chen paused,
"We want to close these three contracts at a price of 295 US Dollar. 160,000 contracts, all of them. Can you help contact your boss?"
Lin Shicheng was silent for two seconds. "Michael, do you know what the current market price is?"
Of course Michael Chen knows.
On September 10, Tesla's stock price closed at around 285 US Dollar.
Strike Price 350 US Dollar's Put Option has an intrinsic value of 65 US Dollar.
Era Vanguard holds 160,000 contracts, corresponding to a market value of more than 1 billion US Dollar.
295 US Dollar closing the position means that Era Vanguard gives up part of the intrinsic value of Put Option in exchange for cash.
Goldman Sachs, JPMorgan Chase and Morgan Stanley can avoid greater losses.
Lin Shicheng said, "I will tell the boss."
After hanging up the phone, Lin Shicheng received another call from JPMorgan Chase and Morgan Stanley, which meant the same thing.
The judgments of the three investment banks are surprisingly consistent - the stock price of Tesla will continue to fall.
The reason is good: the SEC's investigation is escalating, subpoenas have been issued, and Board of Directors has been asked to provide records of communications related to the privatization.
Saudi Sovereign Fund has not publicly expressed support so far, and its financial commitments have always remained verbal.
The Short Selling institution has made a comeback, and the Short Sellers position has returned to the level before the tweet was released.
The Wall Street Journal quoted people familiar with the matter as saying that Department of Justice is also considering whether to launch a criminal investigation into Elon Musk's privatization statement.
To make matters worse, the production capacity problem of Model 3 has not been solved at all. The weekly production capacity of Fremont Factory is still hovering around 2,000 vehicles, which is far lower than the 5,000 vehicles promised by Elon Musk.
Tesla lost 743 million US Dollar in the second quarter. Cash flow is being consumed at an alarming rate, and all Cash Reserves may be exhausted before the end of the year.
Citigroup Bank just issued a report, lowering the target price of Tesla from 340 US Dollar to 250 US Dollar.
The investment bank believes that closing the position of 295 US Dollar is a rational choice.
After receiving the message from Lin Shicheng, Zhao Chen did not rush to reply.
He stood in front of the office window, looking at the Yangtze River outside the window, running through those numbers in his mind.
295 US Dollar closing the position means that he gave up part of the profit of Put Option in advance.
The current stock price is 285 US Dollar, and the intrinsic value of Put Option is 65 US Dollar.
If the position is closed, he can quickly recover about 1.04 billion US Dollar, minus the 160 million Premium cost, and the net profit is close to 9 US Dollar.
But he doesn't plan to do that.
He predicts that Tesla's decline will not end.
Short Sellers is coming with force, the SEC's investigation may escalate at any time, the criminal investigation of Department of Justice is not groundless, and there is no hope of solving the Model 3 production capacity problem before the end of the year.
Citigroup, Goldman Sachs, and Morgan Stanley are all lowering their target prices, and the most pessimistic ones have seen prices below 200 US Dollar.
The combination of these factors is enough to push the stock price of Tesla to a lower position.
On the other hand, investment banks' eagerness to liquidate positions is a signal in itself.
They are not a charity, they want to close their positions because they know the stock price will continue to fall.
If they think 295 US Dollar is already the bottom, they will not rush to close their positions - they will wait for the stock price to rebound and let Put Option automatically return to zero.
Their eagerness to close their positions just shows that they judge that the stock price will go down.
Zhao Chen picked up the phone and sent a message back to Lin Shicheng:
"Tell Michael, 295 US Dollar closes the position, I don't agree."
Lin Shicheng didn't ask any more questions and only said one word, "Okay."
Zhao Chen put the phone on the table, he knew that this game was not over yet.
The SEC's investigation, Department of Justice's intervention, Short Sellers's sniping, and the production capacity dilemma - everything is pushing Tesla into a deeper abyss.
And the Put Option in his hand will bloom in the abyss.
As for the rumors in the market that he was going to liquidate his positions, he didn't care at all.
On the day when he sells Put Option, the market will naturally know that Era Vanguard will not sell Tesla.
16.6 million shares of Common Stock, none of which will be sold.