How to power up your POWR pairs trading to reduce risk and increase returns across large ranges without changing market conditions.
After a rocky start to 2023, stocks have returned to more or less flat this year.
The NASDAQ 100 (QQQ) is still well above 8% in 2023, but is down more than 50% from its early February high. The S&P 500 (SPY) and Russell 2000 (IWM) have fallen further and are clinging to their modest gains this year. Dow Jones Industrials (DIA) is now firmly in negative territory in 2023.
In 2022, the roles reversed, with DIA being by far the best performer among the four indices (down just under 14%) and QQQ being the worst (down over 25%).
This type of large range and unchanging market environment makes buying stocks more difficult and imposes a distinct premium on stock selection. Revealing the worst stocks in 2023 will give them a decisive edge.
This is exactly the approach that has been very successful with the POWR option. It coined the term POWR pairs trading.
We start by looking at bullish calls on the highest rated stocks and bearish puts on the lowest rated stocks. This eliminates much of the overall market exposure and narrows the relative performance down to the power of his POWR rating. As you can see in the chart below, the higher rated stocks significantly outperformed the lower rated stocks.
We then identify situations where lower-rated stocks significantly outperform higher-rated stocks and stand to benefit from a convergence between the two that is expected to return to a historically traditional relationship. Previously, he used this pairing philosophy all the time in his two stocks in the same industry to further reduce risk.
We also always consider implied volatility (IV) in all trading decisions. POWR Options buys relatively cheap options to make the overall odds even more favorable.
However, for our latest POWR pair trade, we decided to abandon the same industry requirement and only look at buying good stocks, buying bad stocks, and shorting bad stocks.
It has become a very viable addition approach to our pairs trading philosophy.
While not a “traditional” pair trade, it is still a POWR rated performance pair trade as the two stocks are in different industries.
Buying a bearish put buys the much lower-rated but better-performing Alcoa (AA), while buying a bullish call leads to the much higher-rated but much-underperforming Bristol-Myers Squibb (BMY). increase.
D Rating – Sell – Alcoa (AA) is trading at 2023 highs, up 22%.
Ratings – Bullish – Bristol-Myers (BMY) is just off its year-to-date lows, down about 3% year-to-date.
The chart below shows the comparative performance so far in 2023. Notice how AA plummeted in his February while BMY remained flat-lined. However, since the end of February, AA has exploded again and BMY has fallen. The performance difference reached 25%.
Expect AA to underperform relative to BMY in the coming weeks as the price performance of the two stocks converge as in the past.
On March 3, the portfolio of POWR options purchased AA’s June puts at $50 at $3.90 ($390 per option), while simultaneously buying BMY’s June calls at $67.50 at $4.20 per option ($4.20 per option). dollars) purchased. Total cost was $810.
Fast forward to Friday, March 10th. We can see that AA has fallen more than 17% of his since the pair started trading (highlighted in red). BMY declined as well, but only by just over 3.5%.
This ended trading on the pair as the spread converged dramatically. The original performance difference, which on March 3 he was over 25%, on March 10 he narrowed or converged by more than half to just over 11%.
Equally important, implied volatility rose on that timeframe. This pushed both AA long puts and BMY long calls higher. The AA put went from 53.81 IV to 56.30 IV. BMY Call rose from 21.14 IV to 22.28 IV.
Closed a bullish BMY call for a loss of $120. We broke out of the bearish AA put and made a profit of $290. Net overall profit was $170 ($290 -$120). Below is the actual transaction data.
The net profit margin on the transaction was just over 20% ($170 net profit / $810 total initial spend). The event is only held for one week. In on Monday, out on Friday.
Investors and traders looking for similar low-risk but solid short-term returns should consider using the POWR pair trading approach to significantly reduce the downside, but also provide a lot of upside for gains. Please consider leaving.
The concepts behind options trading are simpler than most people realize, but applying those concepts to consistently winning options trading is no easy task.
The solution is to start 30 days and let me do the heavy lifting for you. POWR Options Newsletter.
I have been discovering the best options trades for over 30 years and using the quantitative power of POWR ratings as a starting point: 82% win rate in last 17 closed deals!
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Now you have a good deal!
Editor, POWR Options Newsletter
Shares closed at $385.91 on Friday, down $5.65 (-1.44%). Year-to-date, he’s up 0.91% against the benchmark S&P 500 index’s gain of 0.91% 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.
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