When most people think about investing in stocks, they instinctively think about the stock market’s recent performance. Market movements are often taken as a proxy for whether it is a good time to invest. Stock pair trading ignores how the market is doing at any given time. In fact, it even ignores how specific sectors of the market – for example, banking, technology, pharmaceuticals, etc. – are performing. Investors can trade stocks relative to the performance of other stocks in the same category. How the market or a particular sector is doing is irrelevant.
If any of the above sounds confusing, don’t worry. You’re about to discover how easy it is to start betting on stock pairs. Below, we’ll give you a quick overview of pair options, so you’ll have a firm grasp on the foundations. You’ll then learn about the two types of stock pair trading offered by a select few binary options brokers.
By the time you digest the information below, you’ll be ready to dive into your first trade. We’ll describe exactly what you can expect from the experience.
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An Introduction To Stock Pair Trading
The concept of pair trading was developed in the 1980s and popularized by the financial services powerhouse Morgan Stanley. The basic idea is to trade one stock against another in the same niche, measuring their relative performance.
Stocks in the same niche are generally expected to move in correlation to one another based on the performance of the sector. For example, when the banking sector experiences an uptrend, both Wells Fargo and Bank of America are expected to move upward in unison. Pair trading takes advantage of gaps in the pricing trend lines between two correlated stocks. Such gaps are believed to be temporary, and thus are expected to eventually close.
A trader who backs the underperforming stock would profit when the stock’s price inevitably rises. His return is based on the extent of the rise. The more the gap shrinks, the greater his return.
Pair options, the type of contract offered by some binary options brokers, are a variation on traditional stock pair trading. As with other binary options, the contract represents an all-or-nothing trade. If you predict that one of the two stocks will outperform the other, and it does so, you’ll receive a payout. If the stock you select underperforms the other, you’ll lose your initial investment. Again, all or nothing.
The most popular broker in this field is StockPair.com. Its trading platform currently offers two types of stock pair options: fixed return options and floating return options. We’ll explain how they work in the following sections.
Fixed Pair Options
A fixed pair option is the simpler of the two contracts. Two highly-correlated stocks are paired against each other. Traders choose the one they believe will outperform the other. The performances of the two stocks are measured from the start of the trade to its expiration, and compared against one another. The one with the best relative performance is considered the winner.
For example, suppose you want to open a trade for a stock pair featuring Google and Yahoo (StockPair.com has a large list of pairs from which to choose). You predict that Google will perform better than Yahoo. With that in mind, you select the contract’s expiration, which can range from 60 minutes to 150 days, and commit $100 to the trade. Along the way, you also note that StockPair.com is paying an 84 percent return.
Prior to the contract’s expiry, suppose Google does indeed perform better than Yahoo. In this case, you would receive a $184 payout. This includes your original $100 plus the $84 return promised by the trading platform.
But suppose Yahoo had performed better. If that had been the case, you would have lost your initial investment.
StockPair allows you to close your positions early – that is, before your trades expire. When you take advantage of this feature, you’ll receive the payout posted in real time by the trade. This can be useful if your pair option is in the money, but you suspect it may turn against you before it expires.
Floating Pair Options
A floating pair option works similarly to a fixed pair option, but poses a few differences. First, while the latter allows you to choose your trade’s expiry, this type of contract does not. It expires in a day, week, or month, depending on the trade.
Second, a floating pair option compares the performances of the trade’s two underlying stocks during a period that has already been chosen. For example, suppose the contract is active from the start of the trading day through the day’s end. Even if you come into the trade at 11:00 a.m., the performances of the stocks are still compared for the trading period that has already been established. In other words, it doesn’t matter when you come into the trade.
It’s important to realize that the asset you choose in a floating return option may have already fallen behind – i.e. may be underperforming – by the time you arrive. In that case, it would need to make up ground in order for the trade to expire in the money.
Let’s use our Google-Yahoo example from earlier to demonstrate how this works…
Suppose, as before, you expect Google to outperform Yahoo, and take a $100 position in the contract. You execute the trade at noon while noticing that Google has already fallen behind since trading began hours ago. Because Google must stage a considerable comeback in order to put the contract in the money, the potential return is listed as 300 percent.
If Google manages to make up ground and outperform Yahoo by the end of the trading day, you’ll receive a $400 payout. This payout includes your initial $100 investment plus the $300 return promised by the broker. If Google were unable to stage a comeback substantial enough to outperform Yahoo, you would lose your $100 investment.
As with fixed return options, StockPair.com gives you the ability to close your positions early. You’ll receive the payout posted next to the trade.
StockPair.com – The Titan Of Stock Pair Options
StockPair is currently the biggest and best-known player in the pair options trading niche. They launched in 2010 with an extremely user-friendly trading platform and a long list of assets and stock pairs. Not surprisingly, the company has quickly gained a positive reputation.
It’s worth noting that pair options trading currently occupies a small niche within the much broader binary options trading industry. There are very few brokers that offer stock pairs, and as a result, very few that offer a reasonable comparison to StockPair.com.
Having said that, the site and its trading platform are easy to use, so beginners can get started very quickly. The charting provided by the software is intuitive, which helps to simplify an otherwise complex concept.
An important aspect of any binary options broker, whether it offers pair options trading or not, is the reliability with which it sends payouts to its customers. Here, StockPair has maintained a stellar track record throughout its short history. If issues surface, they can be resolved by contacting the support team via email, live chat, or phone.
How To Get Started Betting On Stock Pairs
Once you register an account at StockPair, and make your initial deposit ($200 minimum), you can start executing pair options within minutes. First, you’ll be asked to select between two categories: Binaries and Pairs. When you choose Pairs, you’ll be presented with a number of stock pairs (for example, BMW / Daimler).
Next, you’ll need to choose the type of option you’d like to trade: fixed pair or floating pair. Both can be selected by clicking on the appropriate tab.
If you select a fixed pair option, you’ll be asked to choose an expiry. As mentioned earlier, it can range from 60 minutes to 150 days.
Next, choose the stock you think will outperform the other. Then, enter the amount you wish to commit to the trade. The trading platform will list the potential payout in clear view, right above a large “Buy” button. Clicking the “Buy” button executes the trade.
Betting on stock pair options is bound to become increasingly popular over the coming year. It gives traders another tool with which they can profit regardless of the performance of the broad market. The overall stock market can be caught in a tailspin while you make money on profitable trades. It’s easy, fun, and exciting. But remember, as with all binary options, pair options trading involves a high degree of risk.