Pairs trade

published 17 May 2018

Pairs traders bet on two assets simultaneously, and many use spread bets to do so. The idea is to profit from the change in the price of, say, one share relative to another.

For example, say you spot that share A is normally priced at twice share B. But recently share A's price has dipped on news that a key director is about to be replaced. The news has also given share B a short-term boost as it is a direct rival. Your view is that this will not make much difference to the performance of the two firms and you expect the 2:1 share price relationship to be re-established quickly. A pairs trade would buy share A (or go long) and sell share B, or go short.

This is a market neutral trade in so far as it won't matter whether the market rises or falls while your bets are open provided the gap or spread widens. However, to be truly market neutral you need to ensure you risk the same on both legs of the trade in sterling terms. So if share A is priced at twice share B, you need to bet double on share B.