How can you place a bet that one stock will outperform another?
February 14, 2010 6:53 PM Subscribe
Is there a term (like straddle, or strangle) where you bet that an underlying stock will outperform another stock?
Let's say I think B will outperform A, and both are currently trading at $100. If I buy a put on A at a $100 strike price, sell a put on B at a $100 strike price, sell an option on A at $100 strike, and buy an option on B at a $100 strike.
Ignoring commission, I only make money if B outperforms A.
Is there a term for this kind of trade?
Let's say I think B will outperform A, and both are currently trading at $100. If I buy a put on A at a $100 strike price, sell a put on B at a $100 strike price, sell an option on A at $100 strike, and buy an option on B at a $100 strike.
Ignoring commission, I only make money if B outperforms A.
Is there a term for this kind of trade?
Best answer: You are synthetically short A and synthetically long B. That is, your position will have the same P&L ramification as if you sold A short and purchased B. While that ignores the premiums paid and received, it is the same. Not sure I would call it a hedge unless there was a previously demonstrated correlation between the two stocks that you now think will deviate from its norm.
A straddle would be if you sold (or purchased) both the put and the call of the same strike of the same stock, let's say the $100 strike. If you sold the straddle, you would be betting that the stock will not deviate from the $100 strike by more than the amount of the premiums received. If you sold the call for $6 and the put for $4, you would be betting that the stock at expiration will be between $90 and $100. Purchasing it for those same prices would be betting on a large move, more than 10% (10/100) before expiration.
Can two differenct stocks be a hedge against each other? Maybe. Consider buying one Mastercard (Ticker: MA) and selling 3 Visa for every one mastercard purchased. IF you chart it, it sort of trades in a range with some deviations which I think is what you would be saying here. The real risk for hedging two stocks in the same industry would be news specific to one company and not the other. (See the mastercard - visa spread above two weeks ago). I would term what you are doing as "pairs trading".
posted by JohnnyGunn at 7:19 PM on February 14, 2010
A straddle would be if you sold (or purchased) both the put and the call of the same strike of the same stock, let's say the $100 strike. If you sold the straddle, you would be betting that the stock will not deviate from the $100 strike by more than the amount of the premiums received. If you sold the call for $6 and the put for $4, you would be betting that the stock at expiration will be between $90 and $100. Purchasing it for those same prices would be betting on a large move, more than 10% (10/100) before expiration.
Can two differenct stocks be a hedge against each other? Maybe. Consider buying one Mastercard (Ticker: MA) and selling 3 Visa for every one mastercard purchased. IF you chart it, it sort of trades in a range with some deviations which I think is what you would be saying here. The real risk for hedging two stocks in the same industry would be news specific to one company and not the other. (See the mastercard - visa spread above two weeks ago). I would term what you are doing as "pairs trading".
posted by JohnnyGunn at 7:19 PM on February 14, 2010
JohnnyGunn has it: all of your options plate-of-beansing there has amounted to buying B and selling short A, once all the premiums are taken into account - and that's the standard way of betting that B will outperform A.
There're also things called "outperformance options", which are basically a call option on the spread (imagine doing that spread above, except you don't have to pay if you're wrong; in return for that, you have to pay the option premium). Those are pretty esoteric, though, and retail investors will usually only find them bundled into structured products with eye-watering sales margins.
posted by The Shiny Thing at 9:58 PM on February 14, 2010
There're also things called "outperformance options", which are basically a call option on the spread (imagine doing that spread above, except you don't have to pay if you're wrong; in return for that, you have to pay the option premium). Those are pretty esoteric, though, and retail investors will usually only find them bundled into structured products with eye-watering sales margins.
posted by The Shiny Thing at 9:58 PM on February 14, 2010
I agree with the above, but just wanted to add in another term I have seen used (in an analyst report I just read).
The report thinks that A will outperform its competitor B, so they say "We continue to recommend a short-term pair trade: long A, short B."
They don't specifically mention doing it with the array of options you suggest, since you can get relatively similar exposure through one long and one short.
But I think "pair trade" can refer to any situation where you are betting on relative performance.
posted by vegetableagony at 7:52 AM on February 16, 2010
The report thinks that A will outperform its competitor B, so they say "We continue to recommend a short-term pair trade: long A, short B."
They don't specifically mention doing it with the array of options you suggest, since you can get relatively similar exposure through one long and one short.
But I think "pair trade" can refer to any situation where you are betting on relative performance.
posted by vegetableagony at 7:52 AM on February 16, 2010
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posted by blue mustard at 7:08 PM on February 14, 2010