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Strategies & Market Trends : Margin Calls - Share The Pain
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To: daffodil who wrote (127)12/11/2000 6:32:28 PM
From: LPS5  Read Replies (1) of 158
 
The trading of equity pairs are one example of a strategy called relative value trading, generally more common in the fixed income world than elsewhere. Arbitrageurs go long one a particular issue while shorting another, sometimes of the different maturities (10-yr vs. 30-yr); sometimes of different qualities (Aaa vs. Aa); and sometimes of different types (10 yr corporate vs. 10 yr Treasury), to bet on the changing shape of a particular yield curve or the convergence/divergence (to specific, historically recurring basis point spreads) between several yield curves.

In the mainstream, these are usually safe bets, especially when paired, to use a bad pun, with stops and proper risk management. But when one or both legs of the trade are in illiquid issues - and particularly if, as in the case of some hedge funds, the position(s) are leveraged - sometimes the very act of unwinding a relative value trade that begins to move against the trader can accelerate both the speed and degree of what is euphemistically called "adverse selection."

It is for this reason that the highly exotic relative value trades executed by Long Term Capital Management prior to its' 1998 collapse were likened to "picking up nickels in front of a bulldozer."

LPS5
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