Wednesday, January 12, 2011

Another Cheap Call Option

As Ambac senior debt is for the bond insurers, TGIC is for the private mortgage insurers. Though TGIC looks to be a little bit farther out of the money, the payoffs could be huge. The recent elimination of TGIC debt makes the possibility of a common stock home run feasible. In fact, common equity is directly behind policyholder and operating liabilities of the subsidiary in seniority.

In the capital structure, this is the inverse of Ambac's situation where the bonds would likely claim all future value of the holding company. One of the greatest values of both these ideas is the long life of the securities. To be sure, we consider our Ambac strike price to be much lower with a high payout in our base case scenario. TGIC is our dark horse. And if he's an outside smoker, we'll make a ton while if he isn't we'll lose our principal which isn't much.

Below is a link to the spreadsheet with a simple model of TGIC's future. You can copy it to your own software in order to manipulate or add variables to see the effects. It is quite sensitive, which is half the idea. The other half is that the actuarial assumed losses are too pessimistic.

The technology team - or Mr. Tapley by another name - has learned a very little about sharing spreadsheets, so rather than paste it in a jumble here I've published a link:

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