Trading The Patent Edge: Hidden Alphas
It looks like alternative data has its uses after all.
In markets, there are hundreds of factors that help demonstrate a company’s future or current value. Whether it’s fundamental factors like their debt-to-equity ratio, technical factors like the distance away from their all-time-high, and even discretionary factors like whether or not people just like the CEO.
However, very little is said about how patents fit into the overall equation. So, we’ll take a dive into how these buggers work, what value they bring to publicly traded companies, and how their power can be captured through trading.
Background — What Do They Even Do?
Patents are legal protections granted by a government to inventors, giving them exclusive rights to their inventions for a certain period of time. The primary purpose of this is to encourage innovation by providing inventors with a temporary monopoly over their creations, allowing them to control how their inventions are used, manufactured, and sold.
To better understand this, let’s look at a real-world example with a company we all know and love:
Apple’s Slide-to-Unlock Patent
The “Slide-to-Unlock” patent covers the famous gesture used to unlock touchscreen devices by swiping a finger across the screen:
Now, just having this patent doesn’t mean that competitors will avoid using the design completely. However, owning the parent does give you reasonable legal rights to defend it if any competitor dares to copy you.
That’s why when Samsung, Apple’s largest competitor, decided to incorporate the feature into their own phones, a lengthy legal battle ensued. By the end, Samsung had to cough up a whopping $120 million to Apple for the patent infringement.
Now, you can see just how large of a boon patents can be for a company; large or small.
So, now that we’ve established that a company’s patents are definitely worth looking into, let’s take a dive into some alternative data to get a better edge.
The Alt Data Edge
In order to apply any of this to real-world markets, we first need to find a clean data source that will get us the information we need.
Luckily for us, we can sail on over to the Patent database hosted by Quiver Quantitative:
So, now that we have our data source, let’s walk through how we can use this to help build a better portfolio.
Scenario:
- We are a small asset manager looking for the company making the next-big-thing
- We are looking for innovators in the renewable energy space, as well as in the machine learning/AI space.
After making a query for the appropriate terms (e.g., “artificial intelligence”), we get back all of the most recent related patents and the respective companies that own them:
From this list, we can get more details about what each patent actually covers:
Now, from this list, we still have to play the ol’ “find the needle in a haystack”, but it’s now an infinitely smaller haystack for our goal.
Much like in our earlier post: Here’s What an ACTUAL Trading Edge Looks Like, the edge comes from the streamlined alternate information pipeline. Even though this database is free, going the alternative data route will still put you in a better position than a common market speculator who has none of this.
Pairing this patent database, with the above mentioned government lobbying and contract data can allow you to find some very interesting special situations.
And like always, the only limit is your creativity as an investor/trader.
If this article piqued your interest, you’d definitely enjoy some of my other posts just like this one:
- Pub-stomping Option Markets with ARIMAX [Code Included]
- I Gutted The Entire Sports Betting Algorithm. [Code Included]
- Futures Sniffing: The Problem With Quantitative Alphas [Code Included]
Happy trading! 😄
