Pair Trade of the Day: Lockheed vs General Dynamic

The costs of CDS protection on Lockheed and General Dynamic are strongly correlated and currently are equal, indicating that credit markets do not consider one firm as more as risk of a major event than the other.



Their stocks are strongly correlated too (R-squared of 0.848, i.e. a correlation of 92%):



However, today's market (shown as a red star on the plot) is an outlier: GD appears way too rich relative to LMT. I would short GD and get long LMT in proportions guided by the slope of the regression line. The upside is about $15 per LMT share (if GD stays around $65, LMT should revert from ~$70 to a regression line level in the mid $80's), or equivalently $15 to $20 per GD share on the short side (if LMT stays around $70, GD should, according to this linear regression, revert from $65 to its trend line in the high $40's).