In addition to investment modalities such as Day Trade and investment funds, investors have a variety of strategies to adopt when starting to invest in the risk market, such as Long Short .
As one of the most adopted options, this strategy has the advantage of reducing the risk of stock trading. Follow the article below and discover the Long Short relationship with arbitrage, in addition to understanding how it works.
Understand the Long Short relationship with arbitrage
Long Short, also known as Long and Short strategy , is an approach in which the investor negotiates the purchase of a stock at the same time as he intends to sell another.
To better understand, the investor must know the concept of financial arbitrage. This is an operation in which there is the purchase of a security with the intention of trading it for a more profitable value, acquiring the profit. Therefore, the arbitration is carried out with the intermediation of a third person, the investor.
Knowing this modality, the investor can use the Long Short strategy to minimize risks — profiting from market fluctuations. That is, this strategy is considered an arbitrage operation.
How it works?
Seeking to take advantage of the existing relationship between the two assets, the Long Short strategy occurs when one share is bought (long) and another traded with an investor (short).
Because it is an operation involving two roles that are linked, they tend to behave in a similar way. This ratio is called the beta index and can be calculated by the investor when choosing the best Long Short funds .
The investor’s profitability is achieved by the difference between the values of the shares; and, by working with two assets, it generates a feeling of security. That is, if one paper suffers devaluation, the sale of the other recovers the loss.
To better understand this operation, we have listed the three main processes that investors will go through if they want to adopt Long Shorts in their asset portfolio. See below.
Instead of buying, the investor has the option of renting securities, however, not all securities are available for this type of transaction. Before planning the Long Short operation , make sure the action is affordable — setting aside capital for lease and cost guarantee.
After completing the purchase or lease, you should look for people interested in negotiating. To complete the Long Short, pay attention to the value offered and what you really need — determined in the planning — so as not to lose out.
Purchase of another stock
Lastly, you should look for stocks that you believe will appreciate in value in a short period of time. This analysis is called long position, as it evaluates the patterns of decline and trends, in addition to implementing fundamental analysis — verification of the company’s history , which can influence the quotation.
What are the advantages of this strategy?
The costs of the Long Short strategy range from trading brokerage, including rent, to the payment of fees from the Stock Exchange (B3). However, this operation generates several advantages for the investor, check the list below.
It does not depend on B3’s performance, only on fluctuations in share values;
Enables operation both in times of boom and bust in the economy,
Allows for increased earnings (leverage), since it has another paper that will be sold as collateral.
Despite being advantageous for investors and entrepreneurs — they receive capital investment — the Long Short has some risks, which should also be taken into account.
The first issue to be mentioned is the analysis of the market, since the investor can make a mistake in the forecast and the stock suffers devaluation. Another item to be pointed out are the costs of the approach — B3 fee, taxes, among others. Therefore, when applying it is good to consider all the pros and cons .
Types of Long Short
Just as there are Long Short funds , this strategy can be used in most stocks traded on the Stock Exchange, but the most common operations are:
Intrasectoral: negotiation between shares of companies in the same sector;
ON Share X PN Share: transaction between shares of the same company (common and preferred),
Subsidiary X parent company: in publicly traded companies controlled by other companies, it is common for investors to take advantage of this relationship by buying shares in both companies — minimizing risks.
It is worth noting that the closer the relationship between the companies, the lower the profitability. This is due to the proximity of the oscillations, therefore, the essential thing is that the actions are linked, but that they present different variations.