Diverging Stocks Set Up Pairs Trade for Goldman Sachs Vs. Deutsche Bank

When news broke of SEC charges of fraud against GS, investors quickly dumped DB out of fear that the SEC would soon target DB for its involvement in creating toxic collateralized debt obligations (CDOs). While the selling in GS has gained momentum, the selling in DB has ever so slightly reversed. On Monday, GS broke support and will likely soon test its February 10-month lows. DB bounced neatly off the converging support of the 50-day moving average (DMA) and the 200DMA. (Charts posted at the end of this post).

This divergent trading action in GS and DB may be setting up an interesting pairs trade. The longer DB appears to escape the SEC’s attention, the more likely the stock will continue to recover its losses. Meanwhile, GS could remain under pressure as long as it takes to resolve this case. If GS escapes the clutches of the SEC unscathed, DB should benefit as well. I prefer to use options for pairs trades to reduce overall risk. Given the increase in implied volatility in GS and DB, I prefer option spreads for one side of the pairs trade to help neutralize the costs of this volatility although this choice caps potential gains. Longer-dated options allow you to sit through the inevitable churn that comes with the pressures of daily headlines, rumors, and breaking news.

Use a 150/155 put spread for the short GS part of the pairs trade. This assumes that a weak GS remains capped by the lower part of the recent congestion. Buy Jul 140 puts if assuming GS may soon become a busted stock and break its February lows. Use a 75/80 call spread for the long DB part of the pairs trade. This assumes that a DB recovery takes the stock to $80 or above. Buy July 85 calls if assuming DB will make a relatively quick recovery and/or will resume its previous near-term upward trend.

More aggressive (and well-capitalized) traders might try some combination of selling DB puts and GS calls as a way of taking advantage of options premiums that are especially high for GS options. Such a setup has the additional benefit of collecting great profits if these stocks end up being dead money (going nowhere) for months to come as the SEC case drags on. Of course, the downside risks are much greater.

GS breaks down further
GS breaks down further

DB bounces - is it on the way to recovery?
DB bounces - is it on the way to recovery?

*All charts created using TeleChart:

Be careful out there!

Full disclosure: long GS shares, long GS put spreads

Leave a Comment

This site uses Akismet to reduce spam. Learn how your comment data is processed.