Some hedge fund traders claimed to have bet against Volkswagen stock before news of the emissions cheating scandal broke, but through luck rather than judgment.
Shares in the German carmaker dropped a fifth on Monday, then another fifth on Tuesday, after the company said up to 11 million of its vehicles could be affected by the growing diesel emissions scandal and governments worldwide launched investigations into the company.
Those fortunate to have sold short, borrowing stock to buy it back at a later date, had done so as part of other trades to do with China, or related to positions in share prices for several carmakers.
Only one fund had a short position large enough to disclose to regulators — Boussard and Gavaudan Partners, a hedge fund based in London managing 3 billion euros of assets. It was an insurance policy, however, rather than a bet, a so-called hedge against another security issued by VW.
Such hedges may have exacerbated the plunge in VW's share price as investors sold short large amounts of shares over the last two days, according to market participants. The shares opened nearly 10 per cent lower on Wednesday, sinking below 100 euros, before rebounding to close at 112 euros following the resignation of chief executive Martin Winterkorn.
Many hedge funds had bought into a 2.5 billion euros so-called mandatory convertible bond issued in 2012 and due to switch into VW preference shares in November. Such investors are attracted by the income, and hedge their investment with a short position in the underlying stock.
If a fund creates the short position using options, which give it the right to sell stock at a set price on a future date, the seller of the option contract can be forced to adjust their own hedging arrangements as the share price moves. The plunge this week forced funds, and banks which have written VW option contracts, to scramble to sell short the carmaker's shares.
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"The need for some hedge funds to sell short more VW shares to hedge the convertible bond has amplified the fall in price," said Emmanuel Boussard, chief investment officer of Boussard and Gavaudan.
B&G owns about 800 million euros in the VW mandatory convertible, but had successfully hedged its position using short-dated options, as well as selling VW shares short, meaning it avoided significant losses.
"We could have lost 160 million euros, but we lost only 2 million euros due to our hedging with options. This has been a perfect storm, but we have survived," Mr Boussard said.
Another hedge fund manager assessed the potential scale of such selling related to the convertible at about 10 million VW shares, but said "while it's a story, it's not the whole story". He said the fundamental problem was the unknown cost to recall millions of cars and to settle regulatory sanctions, potentially in multiple countries.
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Other hedge fund investors also pointed to a collection of uncertainties, including prospects for the size of the diesel car market, federal, state and civil liabilities in the US, as well as the possibility of shareholder litigation in Germany for failing to previously disclose information about the issue.
Two pointed to BP's $18.7 billion settlement with the US government over the Macondo deepwater drilling disaster in the Gulf of Mexico as a precedent, but said this was the wrong analogy as the explosion had been an accident.
One pointed to VW's reputation for spending more than the competition on research and development, and the quality of the cars it produces, making cheating on emissions tests all the more problematic. "This was an engineering lie at a company which is all about engineering," he said.