Long & Short regards buying and selling positions, respectivelly. In this operation, na investor keeps both positions, buying some share or asset and also selling another, with balanced results, without disbursing Money, looking for making profits from the difference between both deals. Many arbitrageurs make use of this technique, taking advantage of distortions caused by movements of speculators and other market players, which make the prices of some assets correlated to distance themselves from each other very much, creating opportunities for gains.
The most common objective for using this strategy is to earn from the increasing spread between two assets, taking advantage of the distortion between their prices. Expenditures tend to zero, as the cash raised from selling an asset can be used for buying another. However, some leveraging happens sometimes, where the sale occurs twice for each purchase.
The best possible scenario for a Long & Short operation is having a drop on prices for the assets sold and an increase for those purchased. If both happens, gains will be in double in both deals. So that means the Long & Short chases a two-sided performance. However, the opposite i salso likely to happen – if prices hike for assets sold and drop for those purchased, the investor fails in both sides. Many investment funds use this strategy, as they can guarantee a minimal performance in spite of any Market trends, using only the correlation between assets.
Types of Long & Short
The main types of Long & Short operation are:
Involve only companies in a same sector, always looking for their correlations. They can be steelmakers, for example, like CSN and Usiminas, or paper and pulp producers, like Fibria and Suzano.
Involve companies from diferente sectors, but having a correlation between them. That’s one of the riskiest Long & Short operations. An example of that is the pair Vale and Petrobras.
Preferred vs Common Stock
The most common type of Long & Short, as risks use to be lower. For this operation, one preferred or common stock is purchased, and another is sold. For instance, Petrobras’ common stock versus Petrobras preferred stock are commonly used for Long & Short moves.
Controlled and Owners
Some companies listed are actually controlled by other companies which are also listed. As their results use to be at least similar, and many times the controlled company actually representes almost the totality of the controller’s equity, that makes the operation easier and less risky. A local example is the duo Banco Itaú and Itaú S.A.
Long & Short positions can be set up with indexes, such as Ibovespa and Small Caps (BOVA11 x SMALL11).
Long & Short can be set with other assets, like derivatives and even commodities. In order to set up Long & Short operations, a guarantee margin is essential, as one of the position will always be sold. Guarantees may include cash or bonds, notes, certificates of deposits, gold and shares.