Transocean Vs. Diamond Offshore: A New Oil & Gas Pair Trade

Citigroup has identified a long/short pair trade in the offshore drilling sector as it previews third quarter results.

A pair trade is a strategy of taking opposing positions in two highly correlated instruments in a bid to mitigate risk.

Citi upgraded shares of Transocean LTD RIG from Neutral to Buy, while it downgraded shares of Diamond Offshore Drilling Inc DO from Neutral to Sell.

At the time of writing, shares of Transocean were sliding 2.21 percent to $10.38 and those of Diamond Offshore were slumping 4 percent to $14.40.

This pair can work in an industry upturn or a protracted downturn, analyst Scott Gruber said in a note. It's still premature to be bullish on offshore drilling fundamentals, the analyst said. (See Gruber's track record here.)

After prior decisions drove initial underperformance through the downturn, the gap has started to reverse for Transocean under new management, according to Citi. The firm projects a further run in either a bullish or bearish outcome.

Diamond Offshore has done a great job of navigating through the downturn — but the valuation has moved too far above the DCF fair value, Gruber said.

Citi projects Transocean can outperform Diamond Offshore by about 80 percent in a bull scenario and by 55 percent in a bear scenario.

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