Many of my readers have written to say they made a killing trading Valeant (VRX) since I told you the stock was “Everything That’s Wrong with the Markets” (Oct. 15, 2015). That trade has certainly gone our way, as VRX crashed from $168.87 to close at $61.31 on Friday. Those VRX March 18, 2016 $50 puts traded as high as $6.10 since my recommendation. The options will expire March 18. If you haven’t already, this week may be a good time to take profits or exit the trade.

But if you were on the wrong side of that trade, you’re in a world of hurt right now.

Valeant’s problems are legion: the company is currently under (at least) two separate SEC investigations, and on February 29 Moody’s Investors Service placed the company’s $31 billion of rated debt on review for downgrade. While investors wait for all of these shoes to drop, the company announced on February 28 that it will postpone its fourth quarter results and conference call with investors (until March 15) and withdraw its financial guidance for 2016. Valeant stock finished the month of February by dropping another 18.41% ($14.85 per share) to $65.80 per share.

Yet some hedge funds bought more stock over the past few weeks. They refuse to throw in the towel despite the fact that the company today bears little resemblance to the one in which the originally invested. VRX’s business model is no longer viable. It can no longer borrow cheaply to buy other drug companies. It can no longer raise drug prices by egregious amounts to line its pockets at the expense of patients.

But some investors stubbornly cling to the belief that the company’s problems will be solved. Some hedge funds have (or had until the stock collapsed) as much as 20-30% of their capital in the company, which is extraordinarily reckless.

The question now is whether it is too late for investors in the hedge funds that own this disaster to submit their redemption notices for March or whether they will have to wait for June to cut their losses (which were entirely foreseeable had the people managing their money been doing their jobs).

Here’s how these investors got tricked….

The “Pro Forma” Dodge Exaggerates Earnings

Valeant is typical of the type of company that hedge funds, activist investors and others feted in the financial press tend to flock to like flies on feces. The company’s financial statements are filled with non-GAAP adjustments that flatter earnings and paint an unduly positive picture of the company’s prospects. Built on a foundation of cheap debt (that is no longer available) and excessive drug price hikes (which are now politically untenable), VRX is a study in how to fool some of the allegedly smart people all of the time.