On Monday, Credit Suisse downgraded Office Depot(ODP) shares to Underperform and reduced their price target to $4 from $6. Still, they'd like to find a way for clients to make some money with little risk. They suggested a pairs trade with Office Max(OMX), a stock they prefer.
A pairs trade involves buying shares of one company (Office Max in this case), while simultaneously shorting shares of another company in the same industry (in this case, Office Depot). Both are equal dollar amounts ($100k long, $100k short), so you're "neutral" in terms of dollar exposure. What's nice about this is you're not taking a position on the overall direction of the stock market, but instead you're betting on one company's shares to outperform the other's.
Over the past year, OMX shares have traded at an average of 2.2 times the value of ODP shares. With the ratio now at 2.00, the trade could return 10% if that ratio reverts to the mean. If it goes back to the high of 3.82, the return would be 91%. If that ratio goes back to the low of 1.32, the downside would be -34%.