From yahoo finance message boards:

“My friend - how much do you know about how hedge fund managers ‘hedge?’ Let’s say you thought the banks were in for a disaster. You would find a stock/s that you thought would suffer and you’d go short. To ‘hedge’ yourself you would go long another company (citi) that would only go up if your short thesis was totally wrong. If you are right and you’ve positioned your capital appropriately, your shorts would go down more than your longs and you’d profit - using very modest leverage. Shorts and total return swaps meant to replicate short positions are not reported on the 13F statements so mere mortals like us will never know what shorts and total return swaps ESL has in place.

Let me ask you a question. Do you really think Eddie Lampert of all people sat there and sucked his thumb while the US banking system melted down and the country basically collapsed if it weren’t for the Fed and the Treasury? Because that’s what happened. Buffett knew that the system was destroyed and the govt would never let GS and GE go down. So he got in front of the Govt. with 10% returns. Why do you think WEB didn’t take common? Because he really doesn’t expect GS or GE to appreciate, but he KNOWS the govt. won’t let them fail and will either pay his 10% coupon or call his preferred. Brilliant. Eddie in same league I guarantee you that Citi was a hedge on a massive banking short. Those homebuilders he bought and the Sallie Mae position — shorts, shorts, shorts on the other side.

Do make grand statements about people’s positions and losses unless you know how to manage a hedge fund.

BTW, I learned this from a handful of Tiger Cubs who learned working for Julian Robertson.”

Everyone now and again, you will find a intelligent post on yahoo message boards. Here are three reasons why I think Lampert didn’t go long only on his Citigroup stake:

1. During the 2007 shareholder meeting, he mentioned he read the Black Swan. The Black Swan touches on the risks of leverage and mortages within Fannie May and Freddie Mac. Also, I believe Lampert was bearish on the economy given all the macro indicators he was seeing through SHLD sales data. I don’t think he was buying Citigroup because he saw tons of upside.

2. Lampert’s hedge fund buddy and fellow SHLD board member is Richard Perry of Perry Capital. Richard Perry has been on the right side of the meltdown by betting against mortgages and subprime lending. I imagine Lampert and Perry exchange views every now and against.

3. Lampert is a deep value investor. Buying Citigroup at 52 week high isn’t Lampert’s investing style. Given the lack of transparency into hedge fund reporting, I dont see the point in trying to extrapolate fund returns.

Re: Conclusion about SHLD - yahoo.com

I liquidated my 370 shares of SHLD for tax purposes. I used the capital to buy 10 contracts of Jan 2011 SHLD 15.00 calls. I purchased the contracts last week for $21.70 per contract. The value of LEAPS have since risen to $31.00.

I currently indirectly own 1600 shares of SHLD through options and LEAPs.

(2) Jan 2010 $ 60 Calls
(4) Jan 2010 $ 80 Calls
(10) Jan 2011 $15 Calls

The Securities and Exchange Commission has rules that limit the use of short selling, by which traders sell stock they don’t own. But Dow Jones Newswires has found cases of market makers skirting those rules with a trade involving stocks and options. It enables them to refresh short positions without having to deliver the stock within six days, as the SEC demands.

The practice isn’t common, and the opaque nature of the options market means it is impossible to identify which market makers are doing this. Nevertheless, the Financial Industry Regulatory Authority told Dow Jones Newswires it has an “active docket” of such cases it is examining.

The trade works like this: A market maker who needs to cover a short position buys the stock from person A and delivers it to person B. The market maker then sells “calls” to person A — options that convey the right to buy a similar amount of stock. Since the market maker is selling the options, he is now in a position to sell the stock. After a day or two, person A exercises the options, obliging the market maker to deliver the shares, leaving him with his original short position.

Since August, Dow Jones has reviewed more than half a dozen cases where this trade appears to have occurred, involving the stock of companies such as Sears Holdings Corp. and American Capital Ltd.

The Financial Industry Regulatory Authority also is reviewing such cases. “These would be sham transactions used to make sure that the market maker maintained its hedging short-stock position,” said Tom Gira, executive vice president for market regulation at Finra.

Tactic Lets Traders Dodge Rule on Short Selling - wsj.com

From WSJ: The German sports-car maker said Friday that its pretax profit in the fiscal year ended July 31 soared 46% to €8.57 billion euros, or about $10.9 billion. Eighty percent of that came not from making cars but from sophisticated financial instruments connected to a protracted takeover bid Porsche Automobil Holding SE has been pursuing for a company many times its size, Volkswagen AG.

The vehicle: “cash-settled options.” The buyer of regular stock options gets the right to buy or sell stock at a certain price by a certain date. But in cash-settled options, as the name implies, the buyer gets the right not to stock but the cash difference between the options’ “strike price” and the market price of the shares when the options are exercised.

Porsche began buying cash-settled options tied to VW stock in 2005, when VW’s share price was below €100. If the price rose, Porsche could exercise the options and receive the difference between the lower strike price and the higher market price. It could then use the money to buy VW shares.

In Germany, an investor needn’t disclose ownership of any size holding of options if they are the type settled in cash instead of shares. That allowed Porsche to build a large stake in VW while keeping the rest of the market unaware of its activity.

Such options have one other important twist: Banks that underwrite them typically hedge their exposure by holding actual shares. That takes these shares out of circulation.

Three things to keep in mind:

1. SHLD’s repurchase program includes the purchase of call and put options:

Share repurchases may be implemented using a variety of methods,
which may include open market purchases, privately negotiated transactions, block trades, accelerated share repurchase transactions, the purchase of call options, the sale of put options or otherwise, or by any combination of such methods.

2. Repurchased shares are still carried on the balance sheet.

As of August 2nd, 2008, SHLD carries $4,798B in repurchased stock on the balance sheet. Is SHLD holding the shares with the intention of reselling the shares at a higher price in the case of a massive short squeeze? With over 20M shares short and majority of outstanding shares held by long term value guys, how will shorts cover their shares?

3. Outstanding shares in the open market

Please read the SHLD short math covered extensively by ValuePlays and this blog.

Only 126M shares exist in the open market. Under the existing repurchase program, SHLD may have repurchased up to $206M of shares (3-4M shares at today’s prices). The total share count may be reduced to fewer than 122M shares. Based on my analysis of SHLD institutional share holdings, insiders and various value funds including Fairholme and Legg Mason control approximately 122M shares. We are getting close to a tipping point in terms of liquidity of SHLD shares.