A pairs trade involves two separate, yet related, option plays -- one bullish, and one bearish -- on two different underlying securities. While it can certainly be classified as a "hedged" strategy, a pairs trade is not a direct hedge in the way that a protective put shields against losses in a stock position.
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- Your Answer
- Pairs Trading
- Pair Trading Lab: Ultimate Pair Trading Tools
- How to set up a Pairs trade
- AlgoTrader Announces Integration with Pair Trading Lab
- Pairs Trading Basics: Correlation, Cointegration And Strategy;
- charts online forex.
- Pairs Trading Basics: Correlation, Cointegration And Strategy.
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Pairs Trading
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Pair Trading Lab: Ultimate Pair Trading Tools
In addition from Paypal, you may now purchase premium membership using credit cards directly. Important: If you have problems retrieving correct and complete historical data or connecting to IB API error , please upgrade your IB Gateway to recent version It fixes important issues, upgrade is highly recommended. Today is the day! First, the pairs trader would purchase a call on a stock with the potential to move higher. The trader would allocate roughly the same amount of money toward the call and put purchases, with both legs typically managed as a single trade.
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 can guarantee a profit if one of the two options more than doubles in price by expiration. Plus, pairs trading allows you to exploit the principle of convexity.
How to set up a Pairs trade
For example, a call with an initial Delta of 0. As a result, though, the call's Delta will be lower, meaning another one-point drop from the stock will result in a slimmer loss for the option. On the flip side, a call's Delta will increase as the underlying equity powers higher, meaning the option's value will rise on each successive gain. Or, simply put, the investor is playing more dollars on the way up, while putting fewer dollars at risk on the way down. See related : Demystifying Delta in Options Trading.
Aside from the appeal of a better night's sleep, part of the beauty of this strategy is that traders can 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 the unexpected, and the hedge helps to reduce the investor's average loss compared to buying a lone call or put.
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. However, the losses typically tend to be small, since the investor is hedging a directional view.
AlgoTrader Announces Integration with Pair Trading Lab
The worst-case scenario is for both stocks to go against the trader's initial predictions, making the call and put worthless at expiration. In addition, stagnation is another one of the pairs trader's enemies—especially if the investor bought relatively expensive options. However, the investor's maximum losses are limited to the initial cash paid to purchase the two options.
Since the premium paid for the two options represents the maximum risk of the pairs trade, the best time to initiate this strategy is against the backdrop of relatively low implied volatility IV. By measuring an option's IV against the stock's correlating historical volatility HV , speculators can gauge the relative richness of the premiums. A rising SVI like in the example above tells us that demand for the equity's near-term options is on the rise, which, naturally, can elevate premiums.