After noticing that CUBA (the closed-end fund, not the country) is trading at a 70% premium to its underlying assets, I started to think about shorting the fund… Here is my thought process and the end result.

First up, why bet against the fund when Fidel Castro is likely on his death bed? The 70% difference between the real value of the fund’s assets and the price in the market is a pretty good start. I can only attribute the recent moves in CUBA’s price to manic buying since it is so divorced from the underlying positions… and manias eventually fade. As long as I use proper position sizing, I should be able to withstand continued mania as long as the fund doesn’t go up by more than 300%…

Now, I wouldn’t want to be net short a fund that might have additional violent moves upward — especially with all the corporate acquisitions happening these days. I’d probably hedge my short position by going long it’s biggest holdings…

If I were to short 100 shares of CUBA, that would be about $1600 to hedge. The largest holdings of the fund would be FLA (19%), FRK (8%), CWCO (8%), RCL (7%), WSO (6%). I could pick up 10, 6, 10, 4, and 4 shares of each respectively to add up to $1500 in long positions to offset the $1600 in short CUBA shares.

One important catch would be commissions and slippage. Commissions would be $120 at $10 per side (both buy and sell) per stock… right away I’m down 8% on my trade before I even look at the slippage. Still, with a 70% premium the 8% in commissions are potentially tolerable. If I can scale up to 200 shares short of CUBA, the commissions would drop down to 4% of the total…

Entering and exiting the position would be a pain, with 6 trades to enter and monitor individually… not to mention that the top 5 holdings only make up 47% of the fund, so there are other holdings that could create an unpleasant surprise.

All this is for naught though, I had a sneaky feeling that the fund was too small to do this effectively anyway. A quick check, and viola — the total fund assets are a microscopic $16 million — $27 million with the premium.

I attempted to preview the short sale at my broker, and my suspicion was confirmed:

! This stock is either ineligible to be shorted or shares must be borrowed externally. Lenders of hard-to-borrow securities charge a fee in the form of interest. Clients who wish to short hard-to-borrow securities and are willing to pay a fee to cover the cost of borrowing those shares, may contact …

No dice. On top of the other challenges, higher fees make this a deal breaker for me… that, and the hysteria over CUBA could easily get much more manic and push the premium constantly higher… an idea that doesn’t thrill me.
The only way to play CUBA is to buy or stand aside.

If you think the hysteria still has room to go, or that news of Fidel’s death will cause an additional upward spike, it might be worth going long as a speculation. With the huge moves lately (daily standard deviation over the last 50 days is over 5%) , I would want to keep an order in the market for both a profit target as well as a stop-loss.

I for one, will stand aside. Despite the fact that I didn’t get a trade out of this idea, I hope the thought process was informative… and maybe even a little amusing.