If ever there was a standout no brainer hedge trade this is it. If you can find two stocks that are roughly the same in underlying value and one is expensive on today's market and one is cheap, you short the expensive one and long the cheap one and wait.
The same goes under certain circumstance when two stocks that correlate, i.e., move together in lock step because they are equivalent, suddenly go their separate way for no reason at all. It could be two oil companies and one fall for apparent temporary reasons.
The value gap is closed by buying the one that’s fallen for no long-term reason and selling the one that hasn’t that is now relatively higher. You sell the OK stock to protect yourself from a market fall and by doing so you are market neutral, as you don’t care what the market does next. This is what hedging is about.
For the Volkswagen, Porsche trade, the deal is: Short Volkswagen, long Porsche.
Volkswagen is, as we all know, in a big mess. They have cheated on their emission tests and face a multibillion dollar fine. Porsche holds over 50% of Volkswagen’s stock in their company, which is little more than a wrapper for that VW holding.
This was a result of the internecine corporate battle of the last decade, between VW and Porsche which saw VW’s stock price shoot up to a $1000 on a short squeeze. It resolved in the end by VW buying Porsche's car business and Porsche getting a near majority holding in VW. Porsche now owns over 50% of VW.
The short squeeze and now the emissions outrage makes it two in a decade and it has been said German car makers are like Wall Street bankers in they are too big to fail and so self-important they believe the rules do not apply to them.
So here we are with VW’s share price making a sharp recovery from its crash. I’ve just sold my position and flipped some of it into Porsche because that hasn’t bounced.
This looks like a simple long Porsche trade on the long side, but anyone wanting to be clever can short VW and long Porsche and end up with a market neutral hedge.
This gap that’s opened up is no short term correlation that got busted:
This goes way back.
The correlation has to be there because Porsche is VW give or take. However after the emissions scandal the wheels have come off the relationship and unless something weird is going on somewhere, it must reestablish itself. The gap is a fat one, full of profit for the brave trader.
DYOR of course but this looks like a no brainer.
There is also the possibility that VW and Porsche have a good way to recover in any event. Both have fallen heavily this year and while we consider it, Porsche has a 5% dividend.
Yes I am long Porsche.