What this means is that everyone is piling into the put options, driving up their price. In theory, options should provide substantial leverage, meaning that a 30% drop in the share price would result in a gain of much greater than 30%. But I ran several scenario analyses on Rino puts and found that even if the share price were to drop by 30%, I would make less than 30% -- this is simply due to the option being overpriced. Herein lies the fundamental problem with put options: timing is absolutely everything.
If you know of a terrible company that is not yet in crisis, the put options are probably very cheap and could provide a massive return. But if the crisis doesn't happen quickly enough, the option loses 100% of its value. Once a company enters crisis mode, such as Rino, investors can be comfortable with timing but then the price inevitably gets overbid making the options unattractive.
As a final thought, what happens to a put option which has value but that is "out of the money" and then the stock is halted ? You can't exercise or sell it so does it expire worthless even when you had made a profit ? I have asked five different people and gotten five different answers. In crisis situations, there is a very real possibility of a stock halt and I wouldn't want to learn the answer to this the hard way. (Incidentally, I am scheduled to speak to several other option traders this week and I will let readers know when I find out the ultimate answer.) If you want to play the smart odds, stay away from put options. On average and over time they are a losing trade.
Lesson #5: Buying on the dips can be the homerun of a lifetime or the kiss of death
Prior to the announcement by Rino's auditor I received a number of emails asking if this could be another homerun buy-on-the-dips play. My answer was a categorical no. With Rino, even before the Frazer announcement, the evidence for fraud was too compelling for several reasons.
Rumors of Rino fraud have been circulating for more than a year
The MW report was pretty much air tight in its accusations
The stock lost analyst support and the company didn't respond to analysts
The earnings call was cancelled
Shockingly, the company made no effort to respond to any of the allegations
This stock is only going one way -- down. Any time a stock like this enters crisis mode, the only thing you can be sure of is extreme volatility. Only play the buy on the dips if you feel that you have a very, very good knowledge of the company and that the short attack is without merit and that the company will prevail over time.
Lesson #6: Cash per share is not a "floor price" for stocks
With ONP, Muddy Waters provided a share price target of "less than one dollar," but they did not provide any rationale for it. The stock bottomed at $4 made substantial moves up since then. As a result, I think some people question the credibility of the $2.45 share price target. Muddy Waters stated that their target share price for Rino is $2.45 because this is the amount of cash per share on the company's books, so at least now they are providing some methodology.