Tuesday

Discrepancy Trading

Post a Comment January 6, 2009 – 4:53 am |   | Permalink |  Print This Post |

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A very profitable and relatively safe way of making money that the The Inflationist subscribes to is in Discrepancy Trading. We take two opposite positions (ie long X and short Y) to take advantage of temporary decoupling between two prices (index, commodity price etc). This style of trading is not new - Jim Rogers describes going long on commodities and short on financials recently. That way, before the market crashed recently, when everything was at all time high, his unrealised losses on financials would have been buffered by his unrealised gains in commodity stocks - and he would hope to profit from greater falls in the financial sector compared to the drop in commodity sector - based on the tenet that “the fundamentals of banks are impaired whilst the fundamentals of commodities are not”. Amongst the financial companies he shorted include Fannie, Freddie and Citibank.

The Inflationist have identified another fantastic opportunity - and that is to take advantage of the temporary (we hope) discrepancy between the ASX and FTSE. We believe that the FTSE have gone up too much too quickly whilst the ASX lags behind. Fundamentally, the ASX (commodity heavy) should outperform the FTSE (finance heavy) in the long term - ie prices of commodities would go through the roof with the impending hyperinflation. As of now, the Australia Cash 200 is trading at 3728 whilst the FTSE is at 4589 - ie a gap of 861. The trade we propose would be to take a long position on Australian index and simultaneously short the FTSE index. As long as the gap narrows, we will be cashing it in.

The Inflationist is taking this trade at $10 AUD a point (with cash of 30k in the bank, we feel that we are not overleveraging - Rule #1: DO NOT overleverage). If the gap opens up further, be unafraid to anchor another discrepancy trade.

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