Pairs Trading

By PAIP Canada staff

For investors who deploy their capital into individual securities and want to minimize risk, a pairs trade may offer the best value. But wait! What is a pairs trade?

When two companies are similar in nature and an investor believes that one of the two companies will outperform the other (in bull and in bear markets), then it makes sense to long (buy) one of the securities and short (sell) the other.

Essentially the investor is trying to pick two separate horses instead of one and only (the winner). The caveat is that the investor has to pick which horse is going to finish ahead of the other.

By investing in, and shorting two different securities, the requirement is the security being purchased outperforms the security being shorted. This translates to the long investment increasing by more than the “other” in bull markets, or declining by less than the “other” in bear markets. Of course, if the dream comes true, then the long position increases in value and the short declines in value… but the opposite can also happen during a nightmare!

Just yesterday, the President of PAIP Canada, Ryan Goldsman, spoke with Michael Hlinka who provided us with what seems to be an excellent pairs trade: long Under Armour Inc Class A (NYSE:UAA), and short Nike Inc (NYSE: NKE).

Although the share prices of these companies are quite different, investors can still undertake a neutral pairs trade by purchasing 1,250 shares of Under Armour and shorting 91 shares of Nike. Both translate to a position totaling USD$10,000.

For those interested in the podcast, it can be found here.