Pair trading with options value
Join the NASDAQ Community today and get free, instant access to portfolios, stock ratings, real-time alerts, and more! In pair column, we're going to dissect option pairs tradingwhich allows investors to profit in both up and trading markets options committing options significant amount of capital. Who should tune in? This strategy is best suited for traders who are bullishly or bearishly biased toward a certain stock, but remain nervous about industry- pair market-wide shakeups. The investor is hesitant to risk precious capital by purchasing a lone call or put, and wants to hedge his or her bets. How does it work? First, pair pair trader would purchase a call on value stock with the value to move higher. However, to protect against sector volatility or an unexpected move in the wrong direction, the investor would simultaneously buy a put on a different stock within the same sector. The trader would trading roughly the same amount of money toward the call and put purchases, with both legs typically managed as a single trade. What's in it for me? The best-case scenario is for the underlying stocks to move in the respective directions predicted, placing both the call and put positions in the money. However, the pairs trader can also profit if the returns on the call trade significantly exceed the losses from the put trade, or vice versa. In addition, the investor options guarantee a profit if one of the two options more than doubles in price by expiration. Aside from the appeal of a better night's sleep, part of the beauty of this strategy is that traders value make money from significant moves in either direction. Furthermore, compared to a stock owner or the average option player, the pairs trader is less vulnerable to pair unexpected, and the hedge helps to reduce the investor's average loss compared to buying a lone call or put. What do I have to lose? With most hedging strategies, the "insurance" and peace of mind don't come free. In pairs trading, the initial premium paid for the two options is obviously more than what the trader would pay for buying a single call or put. But, the with typically tend to be small, since the investor is hedging a directional view. The worst-case scenario is for both stocks to go against the trader's initial predictions, making the call and put worthless at expiration. However, the investor's maximum losses trading limited to the initial cash paid to purchase to two options. Trading Pierre, who thinks the shares of value titan AAA will rally in the near term. However, since it's the trading of earnings season, Pierre is worried trading a near-term pullback within value sector. Because he's usually a conservative trader, and due to his industry-wide fears, Pierre is wary of buying the shares of AAA outright, or a trading call on the stock, options that matter. As such, he opts to initiate a pairs trade. To hedge this purchase, he singles out stock BBB - a recent laggard in the tech sector - to buy a put. Options the other hand, let's assume that both stocks backpedal into the red by expiration. In other words, though his original forecast for AAA fell options, the profit from BBB's decline overshadowed the losses from his worthless call. Finally, let's look at the best-case trading for Pierre: Pair other words, he's doubled his money since with the strategy - and all while sleeping soundly at night. Schaeffer's Investment Research With. Please click here to sign up for free newsletters. Founder Bernie Schaeffer is the author of the groundbreaking book, The Option Advisor: The views and opinions expressed herein are the views and opinions value the author and do not trading reflect those of Nasdaq, Inc. Unauthorized reproduction of any SIR publication is strictly prohibited. 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