Risk-Neutral Pair Trade Idea?

Risk-Neutral Pair Trade: Long UnitedHealth (UNH), Short Humana (HUM)?

UNH’s trading at around $475 now, reflecting an ~13% slide over the past month, after news broke of a DOJ civil fraud probe into its Medicare Advantage (MA) billing practices. This follows a brutal three-month stretch—down ~22%—piled on by the December 2024 assassination of CEO Brian Thompson, an ongoing antitrust investigation, and rising medical costs. Bill Ackman’s X post (Feb 2025) calling out potential fraud, claiming profits are “massively overstated” due to claim denials and upcoding, has lit a match under this mess—let’s break it down.

The DOJ Medicare Advantage Probe

• What’s Happening: The DOJ’s digging into whether UNH juiced Medicare Advantage (MA) payments by logging diagnoses that triggered extra federal cash—sometimes for conditions not treated (WSJ). Historical MA audits (e.g., Humana, 2021) nabbed $200M+ in overpayments; UNH’s much larger size and scale (i.e., >7.8 million MA members) could mean billions if guilty. A 2023 WSJ analysis claimed $8.7B in 2021 alone came from questionable diagnoses, tied to UNH-employed docs and home-visit nurses.  

Likelihood: 60%-70% chance of some truth. “Upcoding” is rampant in MA payments according to Economic Times, and UNH’s size makes it a target. Perhaps not a full-blown “house of cards”, but still a risk.

Downside Priced In for UNH?

• What’s Baked In: The ~25% UNH drop from its peak to $460 captures Thompson’s killing (Dec 2024), a cyberattack ($3B cost), antitrust noise, and the DOJ/Ackman combo.

• Downside Math: If fraud’s real—say, a $5 billion DOJ fine is imposed on UNH—EPS drops ~$5 from $29.7 (2025 consensus estimate), and assuming current forward P/E holds, the stock could retrace to ~$400 (15% to 16% downside). In an “Extreme Case”, (i.e., full $8.7B clawback plus penalties, say a $10B fine), UNH stock could drop to $320-$350 (26% to 33% downside).

Currently, short interest for UNH’s stock is 0.86%, hints at speculative bets, not sell-side exhaustion. A further drop to $400-$440 is plausible, but unless DOJ drops a bomb (e.g., $10B+ or jail time), likely already late for a big short trade win from here.

Long Case for UNH?

• For UNH, a $8.7B hit (if real) is less than 2% of total revenues, which was over $400B for the full year in 2024. It’s a civil probe, not criminal, perhaps mostly priced in with the stock down -25% from its November peak. UNH’s $400B revenue (2024), $20B Free Cash Flow, diversified Optum business (>$250B segment) cushion the potential DOJ blow —a $10B DOJ fine would bruise the company, but unlikely a knockout.

• The -25% three-month drop, smells of panic. At $475, UNH’s forward P/E is ~16x, a discount vs. its ~20x-22x historical average. Wall Street’s 20 plus “Buy/Strong Buy” ratings agree, analysts’ $640 average price target (+35% upside)—Morgan Stanley reaffirmed its $610 stock price target for UNH on 21 February —suggests the recent 7% one-day dip may be an overreaction.

Risk-Neutral Pair Trade:  Long UNH, Short HUM?

• Humana Inc.’s (HUM) stock is down 33% since July 2024 from mostly self-inflicted wounds, i.e., soaring costs, weak Medicare Advantage (MA) rates, Star rating cuts, and enrolment flops. HUM is bleeding solo, and its MA exposure is the cherry on top.

• >80% of HUM revenues are tied to Medicare Advantage (MA).

• If the DOJ’s MA fraud investigation into UNH expands further, HUM stock is likely to drop alongside UNH on contagion risk. In this scenario, the pair trade should offer protection: gains from the short position in HUM would offset losses from the long UNH position.

• If the DOJ probe goes away, both UNH and HUM recover. The sector rallies, though UNH should be poised to outperform HUM, given its larger scale, profitability, and buy ratings from the Wall Street analyst community. In this scenario, the pair trade would profit: gains from long UNH would outpace the drag from HUM short.

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