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will someone squeeze all the silly hedge short

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    How Porsche took the wind out of the hedge funds' sails
    After weeks of being buffeted by the storm of global markets, few hedge funds were expecting the shock wave that broke last weekend.

    By Louise Armitstead and Richard Fletcher
    Last Updated: 11:24PM GMT 28 Oct 2008

    Shortly after 3pm on Sunday, Porsche slipped out its bombshell – in German. So it took a while for hedge fund managers to comprehend the significance.

    One London trader said: "I was on a wet walk and checked my BlackBerry – I ran like a madman back to my house. I assumed the numbers were wrong, but when a broker told me he'd had a dozen panicked calls already, I knew it was true."

    The trader was just one of hundreds of hedge funds that had placed bets worth millions of euros that VW's share price would fall.

    Revelations of secret plans by the maker of the 911 sports car to raise its stake in VW to 75pc was devastating for the short-sellers.

    With Porsche already owning 42.6pc of VW and Lower Saxony 20pc, this additional 31.5pc left little more than 5pc of shares free to cover short positions that amounted to nearly 13pc of the company's stock.

    Porsche said it was letting the market know "to give short-sellers the opportunity to close their positions unhurriedly and without bigger risk''.

    But the biggest short squeeze in recent memory was about to take place instead.

    As soon as the markets opened on Monday, hedge funds and investment banks' proprietary trading desks scrambled to cover their short positions. The demand for stock sent the shares soaring, increasing the losses on the short positions and forcing others that had hoped to
    hang on to become forced buyers too.

    All day yesterday, the panic to get out compounded the situation: at one stage, VW temporarily became the world's biggest company by market value.

    As the losses have grown, so has the indignation. The hedge funds feel unfairly caught out. VW has been a popular "short".

    The auto industry around the world has been one of the hardest hit by the turmoil in financial markets. For instance, the "Detroit-Three" – Chrysler, Ford and General Motors – are in line to receive emergency funding from the American government. Meanwhile VW shares have traded far above the fair value generally agreed by analysts.

    In addition, there has been a wide gap between the trading of the ordinary shares and the preference shares, an anomaly that has attracted big arbitrageurs to the stock.

    Shorting the ordinary shares and buying preference shares has been one of the most popular trades for months, according to banking sources. But the traders didn't know that Porsche was building a secret stake in its rival.

    Rather than acquiring the shares directly – which would have to have been disclosed – Porsche acquired cash settled call options from a group of investment banks. Under German rules, neither the banks – which all held 4.99pc or less – nor Porsche were under any obligation to declare the stake.

    Porsche was not the first to use the call options to build a stake: in July, German ball bearing manufacturer Schaeffler, Dresdner Bank and Royal Bank of Scotland acquired 30pc in tyre and automobile parts manufacturer Continental ahead of a bid using a similar structure.

    Porsche's movement has sparked calls of foul play. "The regulator needs to investigate,'' Piers Hillier, head of European equities at WestLB Mellon Asset Management, told Bloomberg. "The bigger question has to be why they have not done so already. Porsche's stake-building process is at best obscure."

    Porsche vehemently rejects the accusations. "The ones responsible are those that speculated with huge sums of money on a falling Volkswagen share price," said a spokesman.

    German regulator Bafin has announced that it is looking at the
    VW share movement to see if any insider trading or market manipulation had taken place, but has not yet launched an official investigation.

    Hedge funds are not holding out any hope. The German establishment has made little secret of its contempt for the high-rolling industry, with one senior politician referring to the sector as "locusts".

    One trader said: "This sort of behaviour by a public company wouldn't be allowed in the UK or US. But we can't expect help from the German authorities – this is pay back."
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