Being Short Regeneron
Sunday, June 19, 2011 at 6:45PMWe will probably jinx ourselves by writing this post, but here we go. When trading spreads we often worry about one side gapping against us, especially the short side. That said it seems more often than not we benefit from gaps or sharp stock moves in our spread book. We began thinking about this Friday afternoon when a stock we were short, Regeneron Pharmaceuticals ($REGN), was halted pending news. The news was positive, but the stock opened only about 4% higher and eventually traded below yesterday’s close. I can think of a few examples over the past two months in which we benefitted from a plus or minus 10% move in a stock, including yesterday when Darling International ($DAR), a short of ours, was at one point down 15% on news that the Senate approved an amendment ending ethanol subsidies.
Assuming I don’t have selective memory and I have observed enough data, why is it that we seem to win more than lose from gaps? I think it has to do with the nature of our methodology. We are trading spreads based on statistics. We enter a trade when the spread is a certain number of standard deviations from the mean. So we are often buying stocks that are trading at historically low values, or selling stocks that are trading at historically high values, or some combination of the two. So our longs don’t have a lot of room left to fall and our shorts don’t have a lot of room left to soar. In a book of 50 plus spreads we occasionally take a hit, but so far the gaps have been in our favor.
Written by Norm Winer. Follow me on Twitter and StockTwits.
Reader Comments (2)
As someone who has traded spreads, pairs, etc for a while (both single-stock and macro) I have learned that most of Wall St. is very focused simply on whether the next piece of news will be positive or negative without really considering the price impact of that news (another way of saying "what is priced in?"). When you are positioned against the crowd (as mean reversion strategies will be) you benefit greatly when a piece of news misses expecations even by a bit. And hopefully you dont lose too badly when the news comes in against you as people are already positioned for it. By "news" I mean any market moving piece of information - not always an earnings report, etc. In DAR's case - it was pushing a fairly extreme spread against crop prices, which had started to move down. As soon as DAR figured that out, the sell-off was sharp as no one was positioned for anything but continued good news. That didn't surprise me in the least. The gaps are your friend in (well crafted) mean reversion trades.
Thanks for your comment MLouis!