Could A Large Pair Trade Be Unwinding?

Aug. 6.12 | About: Best Buy (BBY)

Today's news centers on Best Buy (NYSE:BBY), jumping close to 20% on a takeover proposal by its former chairman and founder, Richard Schulze. Schulze is prepared to offer $24-$26 for the retailer.

But perhaps more interesting is the reaction of a couple other stocks, namely hhgregg (NYSE:HGG) and RadioShack (NYSE:RSH). What do these names have in common? They're high-short-interest electronics retailers, just like Best Buy. One could speculate that the market is seeing potential for takeover interest in these names as well. But it might also be something different.

If we look at Amazon.com (NASDAQ:AMZN), we see that it's trading quite weakly for such a strong day in the Nasdaq. What might be happening here is that a widespread pair trade could exist that consisted of shorting the bricks-and-mortar electronics retailers -- such as Best Buy, hhgregg, and Radioshack -- together with a long position in the retailer that is supposed to be killing most of them (much like it supposedly did to Circuit City). That retailer would be Amazon.com.

If this pair trade is widespread, then the takeover offer for Best Buy might be forcing that leg shut. And obviously, when someone in a pair trade sees a reason to close one of the legs, they also close the other. So they're forced to sell their Amazon.com long. The same thing would be happening with other electronics retailers, with shorts closing positions there and hence closing longs in Amazon. Such behavior would explain today's strength in the physical electronics retailers, and the weakness in Amazon.com in the face of a strong Nasdaq.

Conclusion

In all likelihood, today's takeover of Best Buy initiated an unwinding of a pair trade that consisted of shorting electronics retailers and going long Amazon.com.

As an aside, these electronics retailers now have margins that are comparable or greater than Amazon.com's margins. So the thesis that Amazon.com is going to drive them all out of business is beginning to sound not so plausible -- especially since Amazon.com is now starting to be forced to collect sales taxes in the most populous states (Texas and California), which wipes out a large advantage it had in big-ticket electronics sales.

Disclosure: I am short AMZN.