Relative Value Pairs Examples
Relative value trading involves identifying and exploiting pricing inefficiencies between related financial instruments or securities.
The key idea behind relative value trading is to identify and capitalize these pricing discrepancies between related instruments, while hedging out other market risks.
Traders may use various quantitative models, statistical techniques, and fundamental analysis to identify relative value opportunities and determine appropriate trade structures and hedge ratios.
It’s a common strategy employed by hedge funds and proprietary trading firms, as producing returns in up and down environments and not maintaining correlation to traditional investments is a key part of their value proposition.
Key Takeaways – Relative Value Pairs Examples
Here are some examples of relative value pairs trading opportunities (or common securities/instruments used in relative value trades) in various markets:
Equities:
- Mega-cap tech stocks (e.g., Facebook (Meta), Amazon, Apple, Google, Microsoft, Nvidia)
- Large-cap bank stocks (JPMorgan, Bank of America, Citigroup)
- Automakers (General Motors, Ford)
- Oil and gas majors (Exxon, Chevron)
- Factors (e.g., Long Quality, Short Leverage)
Commodities:
- Crude oil and natural gas
- Gold and silver
- Soybeans and corn
- Live cattle and lean hogs
- Soybeans + corn vs. lean hogs (the feed vs. the animal)
Fixed Income:
- US Treasury bonds of different maturities (trading the curve)
- Investment-grade and high-yield corporate bonds
- Government bonds of different countries (e.g., U.S., Germany, Japan)
- Interest rate swaps and Treasury futures
- Inflation-linked bonds and Nominal bonds
Currencies:
- EUR/USD and GBP/USD
- EUR/USD and CHF/USD
- AUD/JPY and NZD/JPY
- USD/CAD and USD/MXN
- Emerging market currency pairs (e.g., USD/TRY, USD/ZAR)
Indices:
- S&P 500 and Nasdaq 100
- DAX and FTSE 100
- Nikkei 225 and Hang Seng
- Sector-specific index pairs (e.g., Energy and Utilities)
The key is identifying pairs that have a strong historical correlation or spread relationship, allowing traders to exploit temporary divergences or mispricings when they occur.
Relative Value Trade Structures
Relative value trade structures involve taking offsetting long and short positions in related securities or instruments to isolate and capture pricing inefficiencies or mispricing between them.
Many traders use them strategically to obtain negative correlation exposure to core asset classes (like equities and other “pro-growth” assets).
A common negative correlation relative value structure when being long equities is:
Long Gold/Short Silver
Precious metals like gold tend to have no long-run correlation with equities.
Silver, however, tends to have a positive correlation with risk assets like stocks because around half of it is used for industrial purposes.
In turn, this makes silver correlate with the broader credit cycle like equities.
Accordingly, a “long gold/short silver” trade can provide a negative correlation exposure to equities.
By going long gold and short silver, traders can potentially profit if equity markets sell off and safe-haven demand drives up gold prices relative to silver.
You can profit even if gold falls as well, as long as silver falls by more.
Long Investment Grade (IG) Government Bonds/Short High Yield Corporate Bonds
IG government bonds tend to have lower risk and have milder correlations with riskier high yield corporate debt.
This position benefits if equity volatility increases, driving a flight to safety into IG government bonds while high yield spreads widen.
Note that this can be a “negative carry” trade.
Because junk bonds have higher risk premiums than IG bonds, if you’re long equal amounts, you have a negative carry on the trade – e.g., long a 4% IG yield and short a 7% HY yield (minus-3%).
You can overweight the IG part to get it to even (in nominal terms), but that becomes less of a relative value exposure.
So you might lose as you wait.
Other examples
- Long Utilities + Consumer Staples Stocks/Short Cyclical Stocks
- Long Dividend Stocks/Short Overvalued/Hypey Growth Stocks
- Long Quality, Short Leverage
Overall
The premise is to structure trades that gain value if equity markets sell off by acting as a hedge against long equity exposure.
Also, be sure to pay attention to borrowing fees and interest on the short leg. For some, shorting is untenable because of these costs.
Precise pair selection, entry/exit levels, and active risk management are important for these relative value negative correlation trades.
Here are some examples of relative value pairs that traders may look to trade:
Cash and Futures
- Treasury bond cash vs. Treasury bond futures
- Equity index cash vs. Equity index futures
Equity and Equity Derivatives
- Automakers like Ford (F) and General Motors (GM).
- If Ford’s earnings cause a sharp divergence from its usual price relationship with GM, a trade opportunity might exist.
- Coca-Cola (KO) and PepsiCo (PEP) usually move in tandem.
- If KO suddenly underperforms significantly compared to its historical relationship with PEP, a relative value trader might take a long position in KO and a short position in PEP, anticipating the prices to converge.
- If S&P 500 and the Dow Jones Industrial Average break out of their usual correlation, a relative value play might be possible.
Fixed Income Instruments
- Government bonds vs. Interest rate swaps
- Corporate bonds vs. Credit default swaps (CDS)
- 2-Year Treasury Note vs. 10-Year Treasury Note (a bet on the flattening/steepening of the yield curve)
Bonds from different issuers with similar credit ratings and maturity dates.
If their yields diverge temporarily, a trader could buy the bond with the higher yield and short the other.
Currencies
The idea is generally if there’s a correlation breakdown between similar currencies (GBP/EUR/CHF or AUD/NZD) it could be a trading opportunity.
Like with all of these, it depends on why the correlation is breaking down.
Commodities
- Crude oil vs. Refined products (gasoline, heating oil – i.e., the crack spread)
- Gold vs. Gold mining stocks
If the spread between these two benchmarks widens significantly due to supply-demand imbalances, geopolitical factors, or transportation costs, a trader might enter a trade expecting the spread to revert to its average.
Related: Inter-Commodity Spreads (ICS) and Relative Value
Convertible Arbitrage
- Convertible bond vs. Underlying stock
Statistical Arbitrage
- Pairs trading (e.g., two highly correlated stocks)
- Sector/Industry basket trades
Volatility Arbitrage
- Options on the same underlying with different implied volatilities
- Options on related underlyings with different implied volatilities
Cross-Asset Relative Value Trading Pairs
This is common in global macro trading styles, where traders will look for trading pairs that are in different asset classes.
For example, let’s say a trader is long oil equities but wants to hedge some of the oil risk.
They notice that the USD interest rate is higher than the CAD interest rate, so they go long the USD/CAD as a positive carry hedge against oil prices falling.
Other examples
- Long REIT ETF/Short 10-Year Treasury – Interest rate hedge for real estate exposure.
- Long TIPS/Short Nominal Bonds – Same asset class technically, but inflation-linked vs. nominal bonds. Trades the inflation differential between inflation-linked and nominal bonds. This gets them positive inflation exposure, given most portfolios are systematically biased toward stable or falling inflation.
- Long Technology Stocks/Short Interest Rate Swaps – Technology stocks often benefit from low interest rate environments that encourage investment and growth in high-tech sectors. A decrease in interest rates can hurt the value of interest rate swaps but boost technology stock prices (all else equal), balancing the portfolio.
Factors to Consider When Choosing Pairs
Correlation
Ideally, the assets in a pair should have a strong historical correlation.
This suggests a greater likelihood of their prices reverting to the mean.
The cause-effect linkages of that historical correlation should still be in place.
Potential Catalysts
Identify events or factors that could lead to a correction of the mispricing (earnings, company news, sector events, etc.)
Liquidity
Make sure both securities are liquid enough to allow you to enter and exit the trades easily.
Not True Arbitrage
Relative value trading is not risk-free.
True arbitrage is nearly riskless, while relative value involves a degree of speculation.
Tools & Research
Traders heavily rely on statistical analysis, historical price relationships, and charting tools to identify potential relative value trading opportunities.
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