What best defines a pairs trade?

A pairs trade is best defined as equal investment amounts in two related securities. This strategy typically involves taking a long position in one security while simultaneously taking a short position in another security that is correlated or related to the first. The goal is to capitalize on relative pricing discrepancies while minimizing market risk, as the paired positions tend to hedge each other.

For instance, if two stocks historically move together, a trader might buy one stock (long position) and sell another (short position) if they believe one is undervalued relative to the other. This approach aims to benefit from the spread or price differential between the two related securities rather than from the overall market movement.

The other choices do not accurately capture the essence of what a pairs trade entails. A single investment in a diversified portfolio refers to a broader investment strategy that does not focus on the relative pricing between two specific securities. Long and short positions in the same stock suggest a separate trading strategy that might imply hedging within a single stock rather than a comparative view between two securities. Buying and selling bonds simultaneously does not relate to pairs trading, since it does not necessarily involve taking equal positions in two related securities.