Explainpairs trading and the “bet” hedge funds were making when theyentered into two different pairs trades that involved VW stock.
The October 6declaration by Porsche as the majority shareholder in Volkswagen wasa game changer in the stoke market given that companies scrambled toget shares some of the remaining shares (Wang 417). They wanted toacquire to acquire the Volkswagen shares following the Porsche’sdisclosure. Additionally, they needed a piece of the share sinceVolkswagen shares were valued high in the stock market and.Therefore, they projected a whopping profit after trading with theshares (Wang 417). Volkswagen was considered the most valuablecompany in the market given that its share exceeds $ 1,125 creating atotal market capitalization of $364 billion and making it the mostvaluable company in the world (Wang 417). Being the largestshareholder, Porsche made the purchase of Volkswagen shares difficultto other companies. As a result, many hedge funds had entered pair’strades involving the Volkswagen stock before Porsche’s disclosure.The hedge funds circulated along the Volkswagen preferred shares andshort Volkswagen common shares (Wang 417). Moreover, many fundscirculated along Porsche common stock and short Volkswagen commonshares.
The hedgefunds scrambled to purchase the valuable Volkswagen shares, raisingthe value of the Volkswagen to previously unimaginable levels. Theupside share price was worsened by the index funds that purchasedVolkswagen shares to maintain proper weighing in the DAX index, asthe Volkswagen share of the index grew with the rising share price.As a result, most hedge funds went into losses since companies wereexpecting of making huge profits out of purchasing the Volkswagensshares. The enormous increase in the share price led to an estimated$ 15 billion loss for hedge funds that entered into the pairs trade(Wang 417). The hedge funds found themselves in a short squeezefollowing the Porsche’s exposé. The scramble in the market led tothe hiking of the Volkswagen price, and the price was unaffordable tohedge funds.
Wang,Shaokang. Porsche, Volkswagen, and CSX. Kellong School of Management.P417.