Tech giants are seeing a profound split in fortunes, and Bank of America has devised a way to profit from their divergence

traders smile frown

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.

8 22 18 faang bat drawdowns COTD

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."

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