Introduction
A pair off is a method of offsetting differences in short and long positions. Brokerage firms purchase and sell open short and long positions and settle the difference in payment. There is no actual delivery of the stocks or securities, only a settlement payment to the relevant brokerage firm.
Understanding a Pair off
A multiple pair off transaction is useful for any type of investment other than swaps and currency contracts. All the trade positions, buy or sell are generally contracted on the same day in which the original purchase or sale are made. In a case where the trades match, a pairoff will enable settlement of risks and the payment of the fees and differences.
A pair off-trade is an illegal activity in many countries. The settlement of differences between brokerage firms is against the regular business activity of brokerage firms. The activity gets characterised as "market manipulation" by trade regulators. The pairing-off and the allocation process occurs over different days and at different time intervals.
An illustration to show the effects of a pair off can be where Broker X agrees with Broker Z to sell 1,000 shares of Company A for Rs 1,00,000. At the same time, Broker Z will sell 1,000 shares of Company A to Broker X for Rs 1,20,000. The difference between the two trades is Rs 20,000. Both the broker firms do not trade in the stock and take delivery. They pair off the difference of Rs 20,000 and close the trades.
There can be multiple pair off or a partial pair off. In partial pair off, a trade is partially paired-off, while in a multiple pair off, among the different parts of a trade, a part gets allocated to specified pools or gets paired-off in the latter portion of the trade. All matching trades help reduce settlement risks and in securing the wire transfer of the fees to brokers.
Conclusion
In a pair off, the brokers specify the instructions for settlement beforehand. The open amount of the trade is settled, and the gain or loss is deducted or paid. The gains from a short position are short-term, and gains from long position may be short term or long term depending on the applicable tax laws.
