Asit Sharma: Yeah, Dylan, well, event derivatives are interesting. These are contracts between two parties that essentially to me, are like a wager on an outcome of an event. You can place event derivative contracts really on anything. If you or I have something that we want to place money one side versus the other, we could use a contract to do that. Now, in just street language. We could gamble on that. We could bet on that. This is a more sophisticated way to do the same as you said. It follows a lot of evolution in the derivative market. People who use futures contracts, options contracts are already in the business of wagering on outcomes. A lot of times, we're crunching financial data when we buy, let's say, a call option, or we are going with our gut instinct, maybe if we buy some futures contracts. But at the end of the day, the length of these contracts has been shortening and shortening and shortening in the marketplace. The CBOE, this is the Chicago Board of Options Exchange has been working on derivative instruments that allow people to place bets that open and close on the same day, options that are really single day dated. You've seen this explosion everywhere, but this has taken to the next level. What bigger event than the biggest one of all that's on everyone's radar screens, at least until November 5th, or shortly thereafter, the US Presidential election.

Dylan Lewis: This is the Super Bowl for speculation and so it makes sense that it would be coming together at this time in the calendar year. You mentioned that this feels like a little bit of an evolution in where a lot of options contracts have been going. To me, it also feels a little bit like the evolution of some other trends like the rise in betting, especially sports betting that we've been seeing and the rise in predictive markets. Some people are probably familiar with the idea of Polymarket. That is a predictive market that has been getting a lot of attention and a lot more speculative trading and betting happening. In fact, Polymarket has accumulated more than two billion dollars in bets on the election, which is just incredible.

Asit Sharma: It's so wild and some of us will question, OK, what's the utility of this? This is just people going putting money on who they think is going to win the US presidential election. Well, people who are involved in these betting markets will tell you this may have a higher degree of accuracy. There are professors out there who are saying. Look, if people are putting their hard dollars on the wager, that means they've done a lot of thinking of the outcome. There's another instance of this, which is pretty interesting to consider, and that is the geographical dispersion of the better. If you have people in swing states who are driving through their neighborhood seeing more signs of one candidate versus the other in people's yards and then going to bet on Polymarket, that may have some predictive value.

There have been, though, recently a few events which make you wonder if this year's betting will mirror what happens in the actual election. That is there are some whales coming in. We're used to think of whales in terms of people who come in and take big positions on options contracts. There have been some large bets placed in Polymarket and some other platforms, which may be shifting sentiment a bit. That's going to be all unraveled after the election. But there are studies that show that these so called prediction markets can be accurate for some events, not all events.

Dylan Lewis: Let's talk a little bit about the Robinhood side of this, because I can't say that I'm particularly surprised by this. I think such a large part of the company's focus over the last few years has been taking these users they have a commission free promise and relationship with and trying to find ways to expand that relationship so that the company can move more and more toward profitability. That's looked like a couple of different things in recent years. They've focused a lot more on deposit, interest bearing accounts. They've focused a lot more on options and crypto trading. This feels a little bit like a next step in trying to build out some of those more high margin trading activity operations.

Asit Sharma: I think so too, Dylan, the equity flow that Robinhood sells to its market makers, in other words, you or I are buying stocks, and it's sending those orders downstream to people who are actually clearing the trades, the money they make off of that is fine. But in its original S1, Robinhood was clearly an options house. That's where they wanted to have most of their volume. Why? Because an options contract is a little bit more complex to handle for a clearing firm so there's a little bit more money to be made there. Once you get into the world of derivatives, options, futures contracts, and now these event driven derivative bets. Well, those present arbitrage opportunities for institutional buyers or people who are just pretty wealthy, like the gold customers of Robinhood, who might have a portfolio they want to hedge. You've got let's say 1,000 shares of Nvidia. I wish I had 1,000 shares of Nvidia.

Dylan Lewis: We all do.

Asit Sharma: We've got 1,000 shares. Maybe you want to take some options contracts to hedge that position. Because of this trading of these derivatives across retail buyers, institutional buyers, that's a market where you want to move if you want to lift your profits, you'll get more money selling those orders, then you will the plain Vanilla equity trades.

Dylan Lewis: If you look at the actual books for Robinhood recently, transaction based revenue up almost 70% year over year to just about 330 million. It is the largest driver of their revenue. It is not the sole reason that they've become profitable in recent quarters. They've also ramped down their expenses, like a lot of more tech growth oriented businesses have. But you have to look at the picture here and say, this is a very large part of how this company is going to be making money and probably trying to interact with their users going forward.

Asit Sharma: Yeah, I agree and that's not to say that they're not focusing on some basics. You mentioned optimizing their cost structure. Something else they're doing is realizing. Hey, we could be making a lot more money on our margin. In other words, lending money to customers who want to trade on margin. Typically, their margin rates were a little higher than the industry so management recently said. We're going to lower those rates and have more people borrow money from us for this, because that is, again, a higher margin stream of revenue for them. It's a little bit of everything, and this derivatives for events is just the latest in Robinhood's evolution as this full service house for its customers.

Dylan Lewis: We'll stick with the world of banking and the world of brokerages. The Consumer Financial Protection Bureau out with some new rules that will affect banks, credit card companies, and FinTech companies. These are so called open banking rules. The idea is that it will be easier for consumers to access and share data with institutions. Also puts more limits on what data collection those firms can do. From consumers, not surprisingly Asit, the banks are not loving this. There's a bank industry group and also, I think, a specific bank that have already filed suit against this last week. It's more rules. It's more regulation. It's more expensive operating environment, but it also feels like a win for consumers.

Asit Sharma: I think so, Dylan. The language around this is vague now, so we're still piecing together exactly what this means, but let's take some simple examples. Number 1, you are a customer who before was evaluated through a third party mechanism like a FICO score and so you really were subject to whatever that FICO score said. In this scenario, maybe a financial institution can get a more holistic picture of you if they can have access to banking transactions, whatever you want to show them, you make your utility payments on time, for example. That's more first party data that should be yours to share.

That now you can share, you can just opt in and say yeah, go ahead and send this all to this other financial institution. Why are banks mad, this or the second example. Let's say you are that person who holds all those Nvidia shares, and you sell some, and you put it in your bank. You've got this fat deposit. Well, maybe you want a higher rate of interest, and you happen to share that information to other institutions that are either banks or have relationships with banks and can offer you a higher deposit rate. Your bank doesn't want to share that information. I'm paying you 3%. I don't want to tell anyone that you've got a few hundred thousand sitting here at 3%. You can see why institutions have mixed views of this. But I think in general, it's a win for the consumer. I agree with you.

Dylan Lewis: It does remind me a little bit of the FTC's new click to cancel rule, which made some waves earlier this month, really making it easier for consumers to end subscriptions in the world of digital products, I think gyms, as well. What I see with both of these stories is there have been some tremendous gains in digital business, and a lot of those gains have accrued to the companies themselves, and their ability to take information, married up with other datasets and get a much more in depth view of the customer. It feels like there's a little bit of a tide shift happening where some of those benefits, that ease of use and sharing information, that ease of cancellation starting to come back to the consumer a little bit.

Asit Sharma: Dylan so much money, so much capital, so much brain power, so much technology has gone into answering questions like this. How can we make it easier for the customer to click and buy our product or service? Make it easy to sell this thing. But when you reverse that equation on that same seller. Well, I want to make it easy for the customer to get the heck out of your service as well, they don't want to expend any brain power or resources or money on that side. You can understand that, too, again, because capitalism is such a thing where we want to protect what we bring in house. I think that the tide is shifting a bit. Everything in capitalism and commerce operates on that pendulum principle that you I talk about sometimes, where when things go too much to one extreme, to make it a fair exchange, it has to move the other way. There are two ways to do that. One, consumers will back, and so you got to change your practices. Number 2, the government will step in and help that swing back to the middle a little bit. That's what we're seeing now.

Dylan Lewis: If the rules stand as currently written, they will not go into effect all that soon for consumers. The largest institutions will have to comply by April 1st, 2026. Some of these smaller covered institutions will not have to comply until April of 2030. There's going to be some lead time, I think, on this story, and one that will probably wind up revisiting a couple times over the next couple of years as the regulatory and cost picture for some of these businesses picks up. I want to wrap us up with one story that is a little bit less about the gears of how finance might work, and a little bit more about how it plays out with a company. We've talked plenty about Boeing. We've talked about the manufacturing issues. We've talked about the CEO exit. The current strike is very well documented. This week, the company in headlines for a dubious milestone. It will be launching a $19 billion stock issuance in order to raise cash, and it is one of the largest issuances ever by a public company. Asit, Boeing is a $95 billion company, 19 billion would be a lot of stock to issue.

Asit Sharma: That's true, Dylan, and surprisingly or not surprisingly, the stock is not down that much today. Like Boeing is telling its shareholders, we're going to dilute you. But at this point, shareholders like. Okay, dilute me, bring some more shareholders in. Let's solve this problem. Let's keep you solvent. Let's let you finish production of the models that you need to. Let's see the workforce come back to work. There was almost some relief for this in the markets, even though as you point out, the amount of the raise, which is potentially as much as 24 billion. It's very material to the current market capitalization of the company, it's material to what's on the balance sheet. At this point, I think what Boeing shareholders want to see is just that they don't or shouldn't have to worry about cash flow.

Cash flow has been negative several quarters and when you have delivery delays, the company can't recognize the revenue. It just pushes it out into the future. While it's a really big stop gap, and it hurts, I think investors were ready for this because one more point here, the thing that would happen if Boeing couldn't raise this money in the capital markets on the equity side, is having to go to the bond markets. This is, one article you shared with me, had it in the headline, they're saving themselves from getting a junk rating for their bond credit rating to go down, trying to raise so much money, at least, 19, 20, 24, $25 billion.

Dylan Lewis: Giving people a sense of the balance sheet here. If you look at Boeing at the end of September, 10 billion in cash, 12 billion in receivables, 53 billion in long term debt. The problem is not getting any easier for them with the strike going on right now. They are losing millions of dollars every day because they are not able to continue producing some of their products, and the company has not produced full year positive net income since 2018. That puts this business in a very tough spot. I don't want to dump on Boeing here. But I think seeing a company like this struggle and then having to resort to share issuances and more creative financing options, to me, really highlights how much harder things get for a company when things are not going well, and the importance of financing when it really plays into the flexibility that a business has.

Asit Sharma: That's very true. There are some companies that get a pass from investors. Boeing has been one for the longest time simply because there are only two real choices in the marketplace. Look at the 777X program. This is a program that customers have been OK waiting for delay after delay after delay now. They're starting to get closer to delivering those aircraft, but because Boeing has this duopoly with Airbus, it's gotten the pass. But that doesn't mean that Boeing can stay afloat indefinitely.

The value of having a balance sheet which has some resilience in it, the ability to go to the capital markets on the equity side, if you need to protect your investment grade rating on the bond side, that's very powerful here, but I will say this about Boeing. They don't have much left in that balance sheet or patience with investors to do this drill again. This money that comes in really needs to be spent constructively, and it needs to go to moving deliveries. Of course, there are some other issues still. There's regulatory risk hang around there. They've got to get approvals to move more 737 out the door. This won't solve all the problems. It's really, show me time for Boeing, if it ever was. It's now within this next, I would say year to two years.

Dylan Lewis: Asit Sharma, thanks for joining me today show.

Asit Sharma: Thanks a lot, Dylan. A lot of fun.

Dylan Lewis: Coming up next. Carvana has been on a wild ride. Motley Fool analyst Yasser El-Shimy joins Mary Long to discuss why so many investors have bet against Carvana, and how that bet has played out.

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Mary Long: Carvana, the used car and e-commerce company is up over 5X since the start of this year. Lest listeners hear that and think, Whoa, the used car market must be a booming. It's worth noting that its closest competitor CarMax is up a measly 13% in the same time. Yasser, what is going on with Carvana stock?

Yasser El-Shimy: Well, quite a lot, Mary, and where do I start? But let's say it has not always been a happy story for Carvana shareholders. Problems started during the pandemic years really where surging demand led the company to pursue a strategy of growth at all costs and investing massively in infrastructure for expected demand that just did not materialize especially after 2022, when higher interest rates basically put a damper on people's ability to afford cars as well as the fact that car prices really skyrocketed during the pandemic and that created a real affordability crunch for many households. All of that worked together with the fact that they also made this acquisition of a wholesale car auctioning company called ADESA, which came at a very unfavorable debt terms, almost 10.5% interest on that loan, just saddled the balance sheet of the company. The market started being very skittish about the company's prospects on financial health as growth turned negative, sales growth. They was still losing money.

Now the balance sheet was really impaired, if you will, there were lots of questions as to whether or not this company was even going to make it. But you mentioned the performance of the stock. Now, if you actually zoom out to Carvana's returns since December 2022, you'll find that Carvana stock has returned nearly 2,400% compared to CarMax's 5%. Now, if you invested your money at that time, you would have effectively found the stock equivalent of the Holy Grail. This was a stock that was effectively priced for bankruptcy, and frankly, it was not too far from that. It had an extremely low valuation 90% of Carvana shares Class A shares, I shouldn't be specific, were sold short on the market. The fact that the company not only did not go bankrupt, thanks to the debtor renegotiation and raising equity, but also turned around the business to become profitable and maybe on path to in fact become one of the most profitable players in that market while gaining market share. All of these factors really combine to create that mother of all short squeezes that we have seen with the stuff.

Mary Long: Let's focus on why that short interest existed in the first place. Why were so many investors betting against Carvana and what has changed since that peak 90% short interest?

Yasser El-Shimy: As I said, the balance sheet of Carvana was in bad shape. It had billions of dollars of debt and less than a billion dollar of cash at the time. That debt was accumulated basically in order to build those IRCs, as they call them, inspection and reconditioning centers throughout the country. Those are facilities that Carvana wanted to build in order to service the use car market across the nation. They can effectively inspect and repair the use vehicles that they source and then flip them in and sell them effectively. But then they went a step further also to go ahead and buy ADESA, which was one of the country's largest wholesale car auctioning companies in order to try and be as vertically integrated as possible.

There was a lot of strategic acumen, if you will, into what Carvana was doing, that they were trying to build the infrastructure and the vertically integrated business model that could support their growth for many years to come. However, this all happened at a time of you can call it the market top of demand, if you will. Again, as I said, during the pandemic, everybody was buying cars because also new cars were in short supply thanks to semiconductor shortage and other reasons. A lot of the interest went into the used car market and Carvana was able to sell more cars for higher prices at that time and expected that demand to just keep going. Of course, once interest rates start rising, that demand somewhat disappeared, and we started seeing actually sales contraction as opposed to sales growth. But even in that tough market, Carvana was able to gain market share against competitors, and they have had to do a lot of cost efficiencies that we can talk about later in order to get into a more healthy financial position. But it was really a confluence of factor that made the market very skittish about Carvana.

Mary Long: You've got what you referred to earlier as the mother of all short squeezes happening with this stock. At the same time, you also do have Carvana improving upon its fundamentals. Earlier this summer, Q2 earnings beat on revenue, net income, earnings per share, operating income. If you're a market observer and you're taking a look at this stock, how do you parse out how much of this rise is attributable to the mother of all short squeezes versus actually improving fundamentals?

Yasser El-Shimy: It's very hard to quantify exactly how much is attributable to a short squeeze versus improving fundamentals. But this very rapid, very strong price increase in the stock usually happens in the context of a short squeeze, not always, but usually. But that rapid and very high increase in share price cannot be sustained unless the fundamentals have improved as well. If you take GameStop as an example, that was the the stock of infamy, if you will, during the pandemic that also experienced a pretty big short squeeze thanks to Wall Street bets on Reddit. That had a massive rise, but also has since fallen quite a bit. The reason is the fundamentals have not supported basically that short squeeze that happened. It was almost an artificial short squeeze for reasons I'm not going to get to right now. But a short squeeze basically happens when you have a stock that is heavily short and suddenly there's some good news that convinces investors that maybe we were wrong to be so pessimistic about this company, and that's when people who are selling these shares short, they need to cover their positions and buy shares. The price rises and creates a feedback loop that feeds on itself. But Carvana, for sure, has shown that it has improved its fundamental outlook, both from a balance sheet perspective, or it has renegotiated its debt with the bond holders and improved its cash position as well. From an operating perspective, we can see that they have become EBITDA positive for the first time in history in 2023, and they expected to in fact reach a 10% EBITDA margin by 2025 and a 20% gross margin in that same year. The fundamentals are improving from an operational and profit perspective, and that has come, of course, at a time when the use car market was in fact contracting, so that makes it all the more impressive and speaks also volumes about the strict fiscal and operating discipline that was born out of necessity in 2022 and 2023 that has allowed Carvana to become a lot leaner than it used to be.

Mary Long: It's a father's son duo, that's behind this business. There's Ernest Garcia II, he's a major shareholder in the company, and then there's Ernest Garcia III, who's co founder and CEO, all told the Garcia family holds about 87% of Carvana's voting share, that's as of 2023. They've both made a lot of money from selling shares in the company? The Junior Garcia hold or sold over two million dollars of Carvana shares this past May. The Elder Garcia sold about $145 million worth of share this past May. And many more since then, if you take a look at our premium stock database full IQ, basically all recent selling of Carvana comes from the Elder Ernest Garcia. We typically like to see founders who have a lot of stake in the game. The Garcias certainly have that. How do you think about founders who are constantly shedding their shares of a company?

Yasser El-Shimy: Thanks for asking that question because the Garcia family's ownership of Carvana is probably one of the most controversial ownership personalities out there, but if you go on Financial Twitter, Fin Twitter, you'll definitely find a lot of very heated opinions on that. But let me just try and take a step back here and say that the ownership is in fact, one of the key risks in investing in Carvana and the complex ownership structure to be exact. The shares flow that trader and public market represent only about one third of the implied shares outstanding. The Garcias own a little bit over 40% of the overall shares. Now, to confuse you a little more, those shares that you buy on the market are class A shares for Carvana Company, but there are also shares in Carvana Group, which are not traded on the public market and have more voting rights. Without getting really into the nitty gritty of that complex structure, all I want to say here is that the Garcias still have a really, really big stake in the company through their ownership of the Carvana group, which is not traded in the public market, and around, I think, 40% of the shares, as I mentioned earlier, and they had bought a lot of the publicly traded shares in Carvana Company when they were raising equity as part of the renegotiating the debt with the bond holders. Now that the market seems to have adopted a more constructive view on the company. They might be just trimming that extra exposure that they created for themselves and taking a little profit in the process as well. But, as I said, they still have a pretty big stake in the company. This is not like they are selling with abandon and heading for that.

Dylan Lewis: As always people in the program, My own stocks mentioned and Motley Fool may have formal recommendations for or against Snowpier suny thing based solely on what you hear. I'm Dylan Lewis. Thanks for listening. We'll be back tomorrow.

Asit Sharma has positions in Nvidia. Dylan Lewis has no position in any of the stocks mentioned. Mary Long has no position in any of the stocks mentioned. Yasser El-Shimy has positions in Carvana and Nvidia. The Motley Fool has positions in and recommends CarMax, Cboe Global Markets, Nvidia, and Q2. The Motley Fool has a disclosure policy.

Boeing, Election Betting, Expanded Options was originally published by The Motley Fool