I frequently like to say that the scientific method can and should be applied to investing. I have started thinking that my bearish investment in the largest railroad in the US, Union Pacific UNP is an experiment of sorts.

Namely, in my experiment I’m trying to prove Paul Samuelson’s dictum that “The market can remain irrational longer than you can remain solvent.” Hopefully, I will not be driven into penury on one UNP short call spread after another ad infinitum.

On February 9, I published a Tear Sheet highlighting a bearish short call spread on Union Pacific with an effective sell price of $130.50. That investment expires today (5/18/2018) and, barring a significant stock price drop tomorrow, we will realize a loss on this transaction. The present stock price of $142.50 is uncomfortably close to my covering $145.00 strike price, suggesting that if the market gods frown on me tomorrow, I will come close to losing the maximum possible on this investment.

This is very frustrating, but as a short-selling friend of mine tells me, unless a short runs against you by 50%, you’re not really shorting. Needless to say, I’m not happy either with Samuelson’s advice or my short selling friend’s.

However, as I mentioned in my review of the company’s first quarter earnings announcement, the company continues to generate operational metrics that imply a much lower valuation than the present stock price. To be intellectually consistent, I will reinitiate a bearish position in Union Pacific on Monday.

I have one other bearish position in Union Pacific, a longer-tenor Synthetic Short which I highlighted in an earlier February Tear Sheet. I initiated the Synthetic Short when the stock was trading at around $137 / share.

I am sorry that this is not working out (much) better. I believe that the market is making a simple extrapolation: the higher oil prices go, the more attractive rail transport will be compared to long-haul trucking.

While this relationship is generally true, We believe that we have already factored in the scenario of significantly higher oil prices in our valuation modeling, and still find that the shares are overvalued.

Aside from the valuation considerations, we are focusing on the potential for trade disruptions related to the Trump Administration’s poor relationship with the rest of the world — Nafta partners, China, Japan, and the EU. Union Pacific is a company that thrives on the basis of global trading relationships, so a disruption of these relationships stands to hurt it.

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