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How we profited from the power of POWR ratings with VAL and HP’s strong pair trading philosophy.
Alfred Winslow Jones is widely known for creating the first hedge funds, or more precisely “hedge funds”, in the late 1940s.
The idea was very basic, creating a hedge or pair trade by shorting stocks that I thought would go down in value and buying stocks that I thought would go up. Both bullish and bearish trades occur at the same time or in pairs, hence the name pair trading.
For example, if you expect Ford to outperform GM, buying Ford (F) and shorting General Motors (GM) is a typical pair trade.
This inherently reduces overall market risk. Sector risk can be significantly reduced if short and long stocks are in the same industry.
While this has been the core strategy of the POWR options portfolio since its inception, it also has several beneficial features.
- Use options instead of stocks to offset short and long positions. A bearish put buys “bad” stocks and a bullish buys “good” stocks. This is a much cheaper way to create hedge trades. It also defines risk.
- Portfolios rely on POWR ratings to help identify the highest rated stocks to buy with a bullish call and the lowest rated stocks to short with a bearish put. Since its founding, Bull (A) and Buy (B) POWR stocks outperformed the S&P 500 by more than three times. Strong F-sell and D-sell POWR stocks are down nearly four times the S&P 500.
- It exposes situations in which lower-rated stocks temporarily outperform higher-rated stocks, providing an additional edge from the expected mean-reversion.
To clarify the process, let’s take a look at a recent pair trade in the POWR options portfolio. This was a combination of long puts on Valaris (VAL) with low D ratings and long calls on Helmerich & Payne (HP) with high B ratings. Both stocks belonged to the energy drilling industry.
The February 10 comparison chart below shows that lower-rated Valaris (VAL) has dramatically outperformed higher-rated Helmerich & Payne (HP) by more than 50% over the past 12 months. Prior to that, we can see that the two stocks were more highly correlated or moved more together.
On February 21st, the comparative performance difference converged to about 10%. Both stocks fell, but VAL fell at a much faster pace than his HP.
Initially, on February 13, the POWR options portfolio purchased HP calls at $5.50 and VAL puts at $5.00 for a total spend of $1050.
After a week, convergence resulted in a profit. The POWR option sold the HP call at $3.50 and the VAL put at $9.50 for a total credit of $1300 or a net profit of $250.
As shown, the overall profit was a total net profit of $250 for the $1050 invested. This equates to a net profit of 23.8% for the week. The short-term returns of low-risk trades are not bad.
All this is accomplished by taking a bullish call position on the well-valued but underperforming Helmerich defined risk and a bearish put position on the low-value but outperforming Valaris.
Details are below.
2023 could be the year stocks go nowhere. This is especially true given that the year following 2022’s disastrous year got off to a red start.
Investors and traders can be well served by having POWR option pairs trading philosophy as part of their trading toolbox. Reducing risk with high return potential is a viable strategy in any market, especially in the current market.
POWR option
what next?
If you’re looking for the best options trading for today’s market, check out our latest presentation. How to trade options with POWR ratingHere’s how to consistently find top options trades while minimizing risk.
If this appeals to you and you would like to learn more about this powerful new options strategy, click below to access this timely investment presentation now.
How to trade options with POWR rating
all the best!
Tim Bigham
Editor, POWR Options Newsletter
VAL shares closed at $65.30 on Friday, up $0.36 (+0.55%). Year-to-date, VAL is down -3.43%, while the benchmark S&P 500 index is up 3.65% over the same period.
About the Author: Tim Bigham
Tim spent 13 years as Chief Options Strategist at Man Securities in Chicago, 4 years as Lead Options Strategist at ThinkorSwim, and 3 years as Market Maker at First Options in Chicago. He appears regularly on Bloomberg TV and TD He contributes weekly to the Ameritrade Network ‘Morning His Trade Live’. His overriding passion is to make the complex world of options easier to understand and more useful to the everyday trader.Tim is the editor POWR option Newsletter. Read Tim’s bio and links to his latest articles.
post How to reduce risk and increase profits with the pair trading approach first appeared StockNews.com