So, I was sitting in this bar...

When I picked up this leaflet about covered warrants, which led me to looking at going short against SCO Group stock.

In case you don't know, a "short position" is - in essence - a bet that the security in question will fall in price; a covered warrant is a derivative that grants the right to buy or sell a security at a specified price - the "exercise price" - like a flexible option contract. As noted by Amoeba Protozoa under Option, options are bad mothers. It's probably important to note that SCO Group, formerly known as Caldera adopted their current name after purchasing SCO Unix from The Santa Cruz Operation, the original SCO, now renamed Tarantella.

What are SCO Group playing at?

So, as you may know, SCO Group allege that everyone who has a copy of linux of or distributes it is infringing their copyright and owes them big money. Upon this announcement being issued, the price of SCO stock (Listed on NASDAQ) jumped several hundred percent, but has since declined, although it still remains way above where it started.

The reaction

The open-source community has on the whole regarded the affair with derision; the NASDAQ clearly regarded the news as fantastic; SCO customers are reported as believing that this confirms that SCO is committed to its unix products; the same media report that various analysts believe that SCO could win this and blah blah blah.

Many people have suggested that this is part of a strategy to have themselves bought out by one of their rather more solid rivals, although company chairman Darl McBride currently denies this, on the grounds that they are now in a "strong position". The reality is that they have managed to attract license fees from Microsoft, which already represents a significant economic rent realised as all they have done to their intellectual property is draw attention to it, rather than enhanced it, repackaged it, or delivered it in new ways, except perhaps with the barrel of a gun.

Lies and Rumours

The current price of SCO stock reflects sentiment regarding possibility of a win (creating upward pressure), possibility of their being wiped out as a result of losing in the courts (creating downwards pressure), and crucially estimates of their ability to generate money by actually selling goods and services. Crucially, SCO has gone from being a company with a nervous customer base and some ropey old code, plus a linux business that never took off to one that is seen as actually being invested in its unix product, not only because of the lawsuit, but rather because of the new product platforms that it has launched at the same time as drawing attention to itself by announcing that everyone owes it money.

As Alannah Myles sang, "Between the Lies and Rumours/there's a whole world of mystery", and at present it looks to me - a man from whom you should not be taking any kind of advice, least of all legal or financial - that the price of SCO Group equities reflects what the market considers fair value for a company trading in their unix systems, discounted for the uncertainty in what will happen, as the various other kinds of pressure cancel each other out. In my further opinion, given the fact that Caldera is very much the lame duck of the linux world, the company is overvalued due to people having just noticed them at a time where they have a lot of positive news, which may well be the whole point of the exercise for SCO Group.

Take a roll of the dice...and get back to the point

Given the various conflicting pressures on SCO Group equities, all kinds of interesting things should be happening in the market for derivatives of their stock (or there would be, were there any such derivatives available, which I haven't been able to confirm). The point of holding put-/call- option-like derivatives is to hedge against risk in the movements of the underlying security, in this case SCO Group stock, so derivatives allowing one to fix an upper or lower price for the stock in the time-frame of interest - 2 to 4 years - should be riding high at present, at a significant premium to their intrinsic (exercise) value. (It is left as an exercise to the reader to determine the expected behaviour of options for other time spans).

So, if I want to take a short position against SCO Group, I need to be sure that my chosen option will be well into the money either at, or before, (depending on the exact kind of derivative) the expiry date, or that the market will increase its belief that SCO Group will suffer significant losses, and that stock prices might fall. Picking a highly geared instrument would be an extremely good choice in my case, - in my humble opinion, which is definitely not advice - where a small fall in price - as perhaps due to the bubble that I posit bursting - will lead to a relatively large increase in the value of a put, so that position will be able to take advantage of any downward adjustment in the price of the stock. The supposed advantage depends on uncertainty in the value of SCO not being significantly decreased, as at present any such derivative's value is going to include a relatively large "time value" accounting for future uncertainty: if that uncertainty goes then a (relatively) large part of the value is gone, and to remain valuable the price of SCO group stock will have to fallen to about the exercise price; meanwhile if uncertainty remains, and the price falls, then - as we are considering a geared derivative - a good return should be realisable.

A FINAL WARNING

Certain - most - kinds of short position can expose you to unlimited liability, and you should never take advice from some random guy on e2. This is not a solicitation or advice to dispose of any kind of security in any way whatsoever. Always make sure that you understand the investments that you make. If unsure consult a qualified professional.