$LNCO Overnight De-Coupling Trade

I talked about sector plays in my previous post, but I wanted to discuss this interesting trade setup before I discussed sector plays some more. Although you could consider this trade to initially stem from a sector move.

I mentioned how $LINE and $LNCO had been moving higher on the back of a larger sector move in oil stocks:

These two made some speculators a lot of money in that move higher, although I doubt there were many who held all three days of that move. Today we had the sector sell-off in oil stocks and commodity stocks overall. A lot of the junky oil stocks that became overextended sold off today and made great shorts. $DNR ended up close to down 40%! 

As a sidenote, I actually shorted $DNR, picking up about 15 cents in a stock that sold off over a dollar. The ATR/3 I had calculated for it was around 21 cents. I think the correct EV-maximizing move was to hold for longer (like the whole 21 cents, maybe a bit more than that), but I don't think you can say that it was a mistake to not have held it the entire day and nail it for a full dollar or more. I don't think there's a way to predict (yet!) that $DNR would have been the stock to collapse when some of the other oil stocks bounced a little after the morning washout, so I think covering too soon here is higher EV than holding and risking potentially puking the position into strength.

But something really interesting to me is a potential $LNCO short into the close (alerted by Tim Sykes). $LNCO and $LINE are very correlated, because $LNCO is a holding company and holds interests in $LINE. You can see for yourself in the graphs I posted.

Both stocks bounced for most of the day, which signaled to me that there were dip buyers in these two stocks. This was somewhat peculiar, since $LNCO and $LINE are junk companies that many predict to be eventually bankrupt. These companies were being bought when other speculative oil companies, some having better fundamentals, were being crushed. I checked r/wallstreetbets and suspected that uninformed dip buyers were likely buying into these two stocks (no doubt setting themselves up to be bagholders), which was holding up the price temporarily. However, the law of junk stocks is that they can move higher a lot (percentage wise), but fall down a lot as well. I suspected that these two stocks would eventually crack and "catch up" to the rest of oil stocks.

That happened in $LINE, as the stock cracked hard into the close, selling off about 35 cents in an hour (which is a huge percentage move on a $1.60 stock). However, $LNCO did not budge in that selloff. $LINE and $LNCO became temporarily de-coupled in price action. Why? Maybe someone big was buying just $LNCO or selling $LINE in that last hour, but my conclusion was that there was clearly an inefficiency.

In other words, I believed $LNCO and $LINE would trade in lockstep again, in which case $LINE would have to move higher to regain its loss or $LNCO would eventually crack and "catch up" by trading much lower to follow the move that $LINE made. So I placed a short position on $LNCO into the close thinking the second scenario was more likely to play out, and I would look to cover in the morning. I am already up in this position overnight, so $LNCO could very much open 10-20% lower. I wish I shorted more, but honestly it was the first time that I've seen this.

It's an interesting scenario, and probably not a scenario that will occur often (at least, often enough to be worth focusing on). But it is very clearly an inefficiency, and something that suggests these lower priced stocks are full of inefficiencies. It should give hope to anyone looking to beat the game. If anyone out there has ideas, I'd be very interested in discussing or figuring out why this setup happened.