In a pair trade, the short provides the investment capital.
You then use the investment capital to enter the long position.
Let me show you how my table was set, then roll through the strategy up to the closing trades today, for a nice net profit.
I have a lot of FLEX shares at a nice gain, some of the most recent were bought at 33 the first week of March using margin. See this post from that date (and please read it, it gives the basic rationale for the relative stock valuations I'm using). Note that FLEX is earning at least 25% more than CLS per share. Couple this with my conclusion that FLEX would beat the JunQ estimate prevalent at that time... and my conclusion that over the next several years, I think its more likely that FLEX can grow earnings faster than CLS, since they're growing off a smaller revenue base, and new telecom contracts will have more impact on FLEX.
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I also concluded that FLEX should trade at a premium of 30-50% on a share price basis, because of CLS's historically poor return on equity (ROE), and return on assets (ROA). This was mentioned in these posts (which no one has ever responded to):
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I jettisoned the shares bought at 33 in the high 40s, then replaced the shares about 15% lower, using some margin, on April 16, then added more the following week at 37-38 when it dropped below 40. These posts reveal the moves:
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I still hold the share acquired in these pullbacks. FLEX popped up into the high 40s, and I sat pat. The rest of the ECM sector was catching up to FLEX's big March move. Then several stocks in the sector moved to unrealistically high relative valuations. I wanted to increase my FLEX position, but was wary of using more margin to buy un-hedged long positions, after the big recent run-ups. Hence the interest in a pair trade. I posted on this last Wednesday, when CLS was trading at 38 1/4, while FLEX was trading at 44.
The neat thing about a pair trade, is the cash from the short sale pays for the long purchase. Hence a buyer who shorted 2400 shares of CLS at 38.25, could buy 2000 shares of FLEX using the money, without increasing his margin interest.
Today the buyer could have closed the FLEX position at 51.00, for a 2000 x (51-44) = $14,000 gain, and closed the CLS position at 38.50 for a $600 loss.
The net gain is $13,600 with no capital tied up, and no margin interest expense.
And the position is hedged. Say both stocks had dropped by 20% in a market bath. Then simply close the CLS position by buying at 30.60, and take the gain on the short sale. This would increase the margin buying power, decreasing the possibility of a margin call, and leave me with the FLEX shares at a real cost to me of 35. That is a price that I would have been happy to add shares at.
The risk in the trade, was that CLS would spurt up past FLEX. But that would be unlikely to cause a margin call. And eventually rational valuations would return. If you look at the relative stock prices for FLEX and CLS, since CLS had their IPO last June, you can see that this pair trade makes sense when FLEX drops below a 25% premium to CLS share price.
I know this kind of trade usually only makes sense for people with large accounts, but $10k here, and $15k there adds up.
In any case, I made good money on my pair trade, and even if you think I'm a joke, I'm still way ahead of a net long position in CLS begun when we first crossed posts on FLEX/CLS relative valuations (when FLEX was 34, and CLS was 27.50).
The last couple of posts you made on this subject are full of mis-representations and reveal your lack of knowledge on this subject. I think you need to keep in mind Stephen Covey's rule discussed in his book "7 Habits for Highly Effective People":
"Seek first to understand, then to be understood."
Paul |
