Ask the Fool The Long and Short of Pairs Trades
Q: What's a "pairs trade"? - R.K., Fairfield, Calif. A: It's the practice of making two related trades at the same time. One is a "long" position (i.e., buying a stock with the expectation that it will increase in value) and the other a "short" position (where you sell a stock you expect will fall, planning to buy it back later at a lower price).
Q:
What's a "pairs trade"? - R.K., Fairfield, Calif.
A:
It's the practice of making two related trades at the same time. One is a "long" position (i.e., buying a stock with the expectation that it will increase in value) and the other a "short" position (where you sell a stock you expect will fall, planning to buy it back later at a lower price).
The two securities will have a strong relation to each other.
For example, when the price of oil recently began falling, some people expected gold to rise. If so, they may have done some pairs trading, buying gold-related securities and shorting oil-related ones.
Q:
What's a company's "burn rate"? - W.G., Decatur, Ill.
A:
It refers to how quickly the company is burning through cash. This isn't often an issue for large, established companies, but with small and quickly growing ones, a glance at the burn rate can be valuable. The number to examine is free cash flow, which is income from operations, less capital expenditures.
For example, imagine that in its most recent quarterly report, the Meteorite Insurance Co. (ticker: HEDSUP) reported negative $20 million in free cash flow, as its cash balance fell to $80 million from $100 million in the previous quarter. It's not unusual for firms to lose money in their early years, but it's also what puts many of them out of business. In HEDSUP's case, at its current burn rate, it'll use up its cash in just a few quarters. To stay alive, it will have to reduce spending (possibly resulting in slower growth) or find more money (perhaps taking on debt or issuing additional stock, diluting value for current shareholders).