I get a lot of feedback about my Covered Call ESPP strategy from efficient market theorists. They tell me that I will make and lose money on the trades based on the efficiency of the market. They commonly forget that markets are composed of people and when it comes to individual transactions there is a buyer and a seller. Howard Marks ranted about this in a recent letter (see below). The fact that transactions have buyers and sellers means that while the market may display efficiencies, each transaction Want access to all of my ESPP content? Book, spreadsheets, training videos, and so on? Sign up for the ESPP Wealth mailing list today!
Understanding who is on both sides of the transaction is important. If you are looking to make a new investment of any kind, an Angel investment, a Real Estate Investment, or purchasing shares of a business on a public market you need to understand who you are investing with and who you are buying the investment from. There are motivations of all the players involved and often the person that you are buying from is selling for a good reason. We can talk about your fellow investors later, for now let’s focus on who you are buying from.
The seller is either making a profit or taking a loss by selling to you
There is no other option. For the single transaction that you are engaging in, the seller is either going to have more or less money than they started with as a result of selling to you. What does that mean for you as the buyer? Can you easily answer these three questions about the profit or loss the seller will have?
- Will the transaction be difficult to execute because of the high or low number of interested parties?
- Are you sure you are buying based on a different thesis than the seller?
- Will you have buyers remorse based on the result the seller will have after the transaction?
The seller either has a better investment to make or would rather sit on cash
Keep in mind that a “better” investment may mean that the seller is moving to another city or country and better simply means local for them. Similarly better may mean more anticipated returns in a different opportunity. It may also mean that they feel this particular investment has no future upside and therefore any upside or higher liquidity (e.g. cash) is more ideal than this investment. Can you easily answer these three questions about the other capital allocation options?
- Why would an investor not want to be in this position – portfolio, sector, specific asset?
- Is there a better option in the same sector that you could gain access to?
- Will the required holding period for this investment meet your return requirements?
The seller may have influences that you do not share
There are a large number of influences on sellers. They may be insiders and have insight into what the future holds for the company. They may be physically moving locations and want to sell their stake in a local business. They may have a shorter or longer time horizon and already realized the profits or losses they are anticipating on the equity they are selling. They may need cash to finance a different investment or in the case of an owner selling his equity may need cash to compliment the team’s labor. Can you easily answer these three questions about the difference between yours and the sellers influences?
- Are there group influences that the seller may be responding to – why aren’t you responding to that same group think?
- Is there an accounting motivation such as end of year/quarter that doesn’t affect you?
- Are there macro or news based influences that you have a long enough timeframe to ignore?
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