One of the ways Hedgefund makes money is illustrated below. Within an industry identify the good company and the bad company. Short the bad company Citigroup (C) and use the funds to buy the good company in this case Bank of America (BAC).
Since their performance differs around 30%. You gained 30% right on notional amount. But wait, you didn't really invest notional amount, you invested the margin you needed to keep in your margin account. So really it's just 30%*P. So return = Gains/Investment = 30%*P/30%*P = 100%! On top of the extraordinary return, you don't need to worry about market volatility, because they cancel each other out.
It's not too hard, I picked BAC and damned C back in September. Haha, I am so full of crap talking about this with the benefit of hindsight.
Look at the investment banks.
Good Bank - Deutsche Bank (DB)
Bad Banks - Merrill Lynch (MER), UBS
Thursday, March 6, 2008
Bad Company, Good Company
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1 comment:
In theory this looks like a really good strategy. But in many ways this trade could turn very bad. In a bull market, if both rise relatively closely(good higher than bad), you'll get margin called on the short position forcing an early sale of the winner and wiping out most of the gains. Worse, you could get the bad higher than the good, making you go in the negative... Still an interesting strategy though.
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