Tech stocks diverging in 2018: BofAML trade idea

Traders
can profit from a divorce in tech stocks.
Spencer Platt/Getty

• US and Chinese tech giants are a lot more divorced from
  each other this year compared to 2017, Bank of America Merrill
  Lynch derivatives analysts observed. 
• They recommended a trade that could profit from the
  split between the FAANG +BAT stocks.

The biggest US and Chinese tech stocks meld together into a
convenient acronym — FAANG + BAT.
But their fortunes are anything but similar right now. 

Facebook, Amazon, Apple, Netflix, Google-parent Alphabet, Baidu,
Alibaba, and Tencent are trading this year with a uniqueness that
marks a sharp about-turn from their harmony in 2018, Bank of
America Merrill Lynch observed. 

“A profound shift appears to be underway towards more divergent
returns on an individual basis,” a team of derivatives analysts
led by Stefano Pascale said in a client note on Tuesday. 

They provided various examples of the “divorce” among the FAANG +
BAT group. 

No sector contributed more to the US stock market’s fervent gains
last year than technology. As of December 20, Alphabet was the
worst year-on-year performer with a 26% gain.

But global tech giants are behaving a lot more uniquely in that
the drawdowns are steeper this year compared to 2017 — -15.4% on
average versus -7% in 2017. 

This factoid takes account of
Tencent’s 25% plunge from its 2018 high after the company
reported its first profit decline in over a decade. But excluding
Tencent, the drawdowns in FAANG + BAT this year are still nearly
twice as worse as in 2017.  

Bank
of America Merrill Lynch

Tencent wasn’t the only tech stock to see a record-breaking
plunge after earnings. Facebook cratered 19% after its
second-quarter earnings, underscoring how much idiosyncratic risk
investors are assigning to the tech giants. 

To benefit from the divergence in tech performance, Pascale
recommended a strategy that involves both buying and selling
options that would profit from their rise.     

Buy Jan19 ATM calls on the individual FAANG+BAT
stocks and sell a Jan19 ATM call on the FAANG+BAT basket for an
indicative upfront cost of 2.5% (40% implied correlation
bid).“

The trend in tech is just a snippet of the bigger divergence
between US and international stocks’ performance. After the Great
Recession, the US economy regained its footing faster than many
others around the world. The momentum
gap between US and European stocks, for example, is now the
widest ever, according to Marko Kolanovic, JPMorgan’s head of
quantitative and derivatives strategy.  

After the market closes on Wednesday, the
bull market in US stocks will surpass the 1990s run to earn
the record for the longest ever. 

“Last year
‘
s synchronized pick-up
in global growth has given way to greater divergence this year,
with US growth materially outpacing other advanced economies
while concerns mount over China
‘
s
growth prospects,” Pascale said. “This could further help support
dispersion between the FAANG and BAT stocks.”