Say there is a highly volatile stock. It averages 20x swings every year.

Open two investment accounts. One long and one short. On average one will crash and the other will go up 20x. So 10x expected gain and minimal expected loss.

What is this strategy?

  • 2
    If you are long an equal number of shares of XYZ in account A as you are short in account B then you are considered to be "short against the box". What you make in account A, you will lose in account B or vice versa. Because you must pay borrow fees when you short the stock, the short account will marginally under perform the long account. This all assumes that you have the wherewithal to support the margin requirement in both accounts. There are no free lunches. Jun 9 '18 at 14:00

Assume the stock is $1 to start. Account A is long 1 share, and Account B is short 1 share.

If the stock goes up to $20, Account A is worth $20, and Account B is worth -$19. Note that it is actually possible to owe money on short investments (in fact, you can owe a theoretically infinite amount). At the end, you're still left with $1. Likewise, when the stock goes down, you would still have $1, so there is no potential to make money. Therefore, this isn't a sensible investment as stated.

What you're describing is more sensible when done via options trading. Options trading is a whole can of worms in of itself, so I won't go too deeply into it here (basically you are buying the "option" to buy or sell stock at a certain price, instead of buying the stock itself.).

In options trading, there is a similar concept to what you described called a "Reverse Iron Condor". This is a more complicated position consisting of several different options which allows a trader to make money when the stock goes significantly up or down. (Note, however, that the trader loses money when the stock does not move at all).

TL;DR That strategy, when implemented via options, is typically called a "Reverse Iron Condor" http://www.theoptionsguide.com/reverse-iron-condor.aspx

  • A "strangle" is a simpler alternative to the reverse iron condor and has greater profit potential. However, since the implied volatility of the stock determines the cost of entering the position, these are a bet that the stock will be more volatile than the market expects. OP says "averages 20x swings every year", so presumably the implied volatility reflects this and there is no edge in an options strategy -- it definitely doesn't produce "10x expected gain" as OP suggests.
    – nanoman
    Jun 16 '18 at 22:51

This sentence is very obvious but the math changed my life. If you make 10% then lose 10% you are not back where you started.

Start: $100

10% gain

$100 + 10% = $110

Then 10% loss

$110 - 10% = $99.00

End $99

When you're dealing with something highly volatile, it's not enough for the swings to be equal, the up swings need to be greater than the down swings. Separately your take the long and short of the same security won't work because you need to pay to borrow the shares/units to short and because if you gain 20x and have a mirror loss of 20x you do not wind up at 10x. Nevermind that 20x is 2,000%...

  • 1
    Your description of beta decay due to a 10% gain followed by a 10% loss in a single account is correct but isn't applicable to the OP's set up. If he's long "X" shares of XYZ in account A and is short "X" shares of XYZ in account B then he what he makes in one account, he loses in the other and the percent gain and percent loss are different for the same "X" dollar move in the respective accounts. Jun 9 '18 at 14:01
  • The beta decay bit isn't meant to answer the question, it's meant as general advice because this really is a poorly contrived question from someone new, it's just to show that some things that's are the sale are not the same. I answer the question later by pointing out borrowing cost of the short position and the fact that a mirrored long short is blown by borrowing costs on the short position.
    – quid
    Jun 9 '18 at 14:58
  • This does not answer the question. OP is clearly looking for a name to a strategy. This answer does not even try to provide a name, nor does it provide any information relevant to the question. OP's strategy, even as stated, is constant-value. This answer is a complete non-sequitur.. Jun 9 '18 at 19:14
  • @StackTracer I purposely did not answer the question. Feel free to downvote. :)
    – quid
    Jun 10 '18 at 2:11

It is not a good idea. The short account has an upper limit on its return even if the stock goes to zero (e.g., maximum 2x for initial 1:1 leverage). Only the long account has unlimited upside.

In addition, the short account has unlimited potential loss. You will be forced to liquidate (margin call) if the stock rises too much. The stock could rise enough to wipe out your short account, then crash and wipe out your long account too.

If you have in mind a more complex strategy in which you adjust the position in the short account to maintain a constant leverage to its current value, you make it much less likely that the short account will go all the way to zero, but you have effectively replicated the strategy of "inverse ETFs". Volatility is then your enemy. If the stock goes up 25%, then down 20%, it is unchanged overall. But your short account would go down 25%, then up 20%, and it would be down 10% overall.

EDIT: To explain further why I answered this way: IMO, OP did not state a clearly defined strategy. Rather, OP expressed a hope for a long-short strategy that would allow easily profiting whether a stock goes up 20x or down 20x. OP did not specify how the short position is managed. If (as others here assume) the short position is not managed (other than making deposits to meet any margin calls), then the overall position is neutral.

But part of OP's scenario is that the short position should be capable of very large gains if the stock goes down 20x, but should only crash to around zero if the stock goes up 20x. This would imply some sort of periodic (daily? hourly?) re-leveraging like an inverse ETF, with attendant decay cost. So given the vague description, I wanted to explain why a low-risk strategy like OP is hoping for doesn't exist.

  • If the OP can't support the margin requirement of the short position then that can lead to issues. If he can, then there is no upper/lower limit issue since what one account makes, the other loses. Therefore, there is no unlimited loss. Jun 9 '18 at 14:02
  • 1
    @BobBaerker Agreed, in the absence of a margin call, OP has a neutral (synthetic cash) position. But I do think it's important to explain that the short account by itself has limited gain and unlimited loss. Best I can tell, OP's thinking is based on the incorrect intuition that (value of short account) ~ 1 / (value of long account), i.e., that the logarithmic returns of the accounts are equal and opposite, and both have limited loss and unlimited gain. If this were true, OP's argument would make sense: "On average one will crash and the other will go up 20x. So 10x expected gain".
    – nanoman
    Jun 9 '18 at 17:17

It is called investing properly. Obviously one of the accounts will gain 20x while the other account goes near zero, so, you will always make money.

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