Pairoff: What it Means, How it Works, Comparisons

What Is a Pairoff?

A pairoff is a purchase and sale of open short and long positions, typically between brokerage firms, that offset with the difference settled in cash.

Understanding a Pairoff

In a pairoff, there is no physical delivery of the securities; instead, the settlement difference between the trades is calculated and sent as a cash payment to the appropriate brokerage firm. This type of activity between brokerage firms is illegal as it is considered to fall under the umbrella of "market manipulation."

As an example of a pairoff in action, consider Brokerage A that agrees to sell 100 shares of Company X to Brokerage B for $25,000. Simultaneously, Brokerage B agrees to sell 100 shares of Company X to Brokerage A for $30,000. The difference between the two trades is $5,000. Instead of actually trading the securities and transferring those shares to their respective accounts, the two brokerage firms pair off. In this case, Brokerage A gives Brokerage B $5,000 instead of doing the actual transaction.

Another, more colloquial, meaning for the term is a transaction in securities markets where offsetting buy and sell trades are settled in cash, based on the difference in the prices between the offsetting trades. The offsetting positions are usually transacted within the same day of the original purchase. In the case of matching trades, a pairoff can reduce settlement risks and security wire transfer fees. It is ultimately a form of speculation.

When conducting this type of pairoff, settlement instructions for the cash wire must be included. The pairoff closes, or draws down, the amount of the open trade by the paired-off amount, and only the associated gain or loss is moved. There can be partial and multiple pairoffs. 

In a partial pairoff, only part of the trade is paired-off, while the other part is either allocated into specified pools or paired-off later against the remaining open trade amount. The pairing-off and allocation process can occur at different intervals and over different days.

Pairoff vs. Multi-Way Pairoff Transactions

A multi-way pairoff transaction can be used for all investment types, except currency and swap investments. Multi-way pairoffs allow a trader to partially or completely pair off multiple long and short tax lots. Closing occurs on the trade date of the multi-way pairoff transaction.

Gains realized from a short position are classified as short-term; gains realized from a long position will be short-term or long-term, depending on the periods defined in the country/tax matrix of the investment's issue country.