Sunday, December 9, 2007

Muckable Hands Are Like Distressed Debt

Let me first explain to you what distressed debt is, if you don’t already know. All companies need to borrow money at some point. They do this by issuing debt, an obligation to pay a lender their principle invested plus some level of interest. This interest could be referred to as “juice,” a term that you gambling junkies may be more familiar with. These companies use this borrowed money to invest in projects that will earn them a higher yield than they are paying to their lenders. Most of the time, these companies are able to service this debt (pay it back) with relatively few problems. However, there are situations where these companies for some reason can no longer pay down their debt. The company goes into financial turmoil (distress) and flirts with bankruptcy. Once they reach this point they can either file for bankruptcy or they can attempt to turn the company around. This is the turning point. The debt that they have issued is no longer desired by investors and it sells for cheap and offers a ridiculously high yield. This is a classic supply and demand issue. The demand is low, so the prices are also low. Nobody wants to mess with this stuff. However, there are times where the companies turn their financial troubles around and start to operate profitably again. When this happens, the debt becomes desirable again. High demand means higher prices, and higher prices mean huge capital gains for those who held on to this distressed debt.

So how does this relate to poker? Distressed debt is like a shitty hand in poker—no one wants to play it. They think it’s shit. This may be true, if they don’t have a trader’s mentality. To put this into context, consider the following example:

There are seven players at the table, besides yourself. You’re the button. Suppose there are three calls before the betting even gets to you. You’re holding 4/5 off-suit. Because there are three callers already, their hands must be relatively strong. Some players may fold your hand, but not a trader. A trader would see this as an opportunity to cash in big. Since there are already three callers plus the small and big blind, most of the players are pot committed. You could raise it up a modest amount and probably get a few callers.

The flop comes out Ace, Two, King. This seems bad for you and great for the others in the hand. If they called your raise, chances are they may be holding an Ace or a King. So they think they’re in great shape. They bet and the pot starts getting bigger. You just call, waiting for that Three to fall so you hit your straight. The turn comes and it’s a Three. You’ve just hit your straight and now have the other players in the hand crushed. But they don’t know it yet and they keep betting. You can raise or just call--your choice. When the cards are finally turned over, you’ve made a large amount on a “shitty” hand.
The point is, to make big money, you have to take risks. Clearly, you won’t win with this strategy every time. In fact, you will probably lose more often than you win. This is the same with trading distressed debt. Even if you win one out of four times with this approach, the winning occasion more than pays for the three losses. Plus, if you pay to see the flop and thereafter realize that you have little chance of winning, you can fold, and limit your losses. But if you think you have a chance to surprise everyone and steal a huge pot, fucking do it.

No comments: