How to boost POWR Pairs Trades to lower risk and increase profit in a large range, no change in the market environment.
After a rip-roaring start to 2023, stocks are back almost unchanged on the year.
The NASDAQ 100 (QQQ) is still up so far in 2023 at a little over 8%, but that’s more than a 50% decline from early February highs. The S&P 500 (SPY) and Russell 2000 (IWM) fell further and are clinging to slight gains for the year. The Dow Jones Industrials (DIA) is now firmly in negative territory in 2023.
The roles were reversed in 2022 with the DIA the best performer (down 14%) of the four indices while the QQQ (down over 25%) the worst.
This type of large range, volatile market environment makes buying stocks difficult and puts a certain premium on stock selection. Using POWR Ratings to uncover the best stocks to buy and the worst stocks to sell will be an even decision in 2023.
That’s exactly the strategy we’ve used with great success at POWR Options. A POWR Pairs Trade to coin the term.
We’ll start by looking at bullish calls on the highest rated stocks and bearish puts on the lowest rated stocks. This removes much of the overall market exposure and dilutes the relative performance to the power of the POWR ratings. Higher rated stocks outperform lower rated stocks to a large extent as shown in the chart below.
We then identify situations where the lower-rated stock has outperformed the higher-rated stock in a big way and is in a position to profit from the expected convergence of the two back to a more traditional historical relationship. In the past, we have always used this philosophy of pairs with two stocks in the same industry to further mitigate risk.
We also always consider implied volatility (IV) in every trading decision. POWR Options buys relatively cheap options to further put the total odds in our favor.
In our latest POWR Pairs Trade, however, we decided to abandon both industry requirements and instead look at buying good stocks that make them bad and shorting bad stocks that make them too good.
This has been a very effective addition strategy to our pairs trading philosophy. A quick walk through our latest POWR Pairs Trade will help shed some light.
Although not a “traditional” pairs trade, since the two stocks are in different industries, it is still a POWR Ratings performance pairs trade.
Buying bearish calls on lower rated but better performing Alcoa (AA) and buying bullish calls on higher rated but lower performing Bristol-Myers Squibb (BMY).
D rated -Sell- Alcoa (AA) is trading at annual highs for 2023, up 22%.
Rated -Strong Buy-Bristol Myers (BMY) is on a low annual decline, down about 3% year-to-date.
The chart below shows the comparative performance so far in 2023. Notice how AA fell sharply in February while BMY hugged the flatline. Since the end of February, however, AA has broken out higher again while BMY has dipped lower. The performance difference reached 25%.
Look for AA to be a relative underperformer to BMY in the coming weeks as the price performance between the two stocks converges as usual.
On March 3, the POWR Options portfolio bought AA June $50 puts for $3.90 ($390 per option) and at the same time bought BMY June $67.50 calls for $4.20 ($4.20) per option. The total combined cost was $810.
Fast forward to Friday March 10. You can see how AA is down over 17% since the pairs trade started (highlighted in red). BMY also fell, but only by more than 3.5%.
This led to the closing of trading pairs as the spread converged sharply. The original performance difference of more than 25% on March 3 had narrowed, or converged, by more than half to just over 11% on March 10.
Just as importantly, implied volatility increased during that period. This gave rise to our long AA puts and long BMY calls. AA puts went from a 53.81 IV to a 56.30 IV. BMY Calls rose from a 21.14 IV to a 22.28 IV.
Exit bullish BMY call for $120 loss. Exiting the bearish AA puts for a profit of $290. Total gross profit is $170 ($290 -$120). The actual trade data can be seen below.
The net percentage gain on the trade is just over 20% ($170 net profit/ $810 initial combined expenditure). The holding period is only one week. On Monday, out on Friday.
Investors and traders looking to generate similar low risk but stable short-term returns may want to consider using the POWR Pairs Trade strategy to significantly reduce the downside but still leave plenty of upside open for in seizing benefits.
What to Do Next?
Although the concepts behind options trading are simpler than most people realize, applying those concepts to consistently make winning options trades is no easy task.
The solution is to let me do the hard work for you, by starting 30 days with my POWR Options newsletter.
I have been discovering the best trade options for over 30 years and with the muscle mass of POWR Ratings as my starting point I have achieved a 82% win rate in my last 17 closed trades!
During your trial, you’ll get full access to the current portfolio, weekly market commentary and every trade alert via text and email.
I will be adding the next 2 exciting trading options (1 call and 1 put) when the market opens this Monday morning, so start your test today so you don’t miss out.
There’s no obligation beyond the 30-day trial, so there’s absolutely no risk in getting started today.
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Tim Bigham
Editor, POWR Options Newsletter
shares closed at $385.91 on Friday, down $-5.65 (-1.44%). Year-to-date, has gained 0.91%, compared to a % increase in the benchmark S&P 500 index over the same period.
About the Author: Tim Biggam
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 for First Options in Chicago. He makes regular appearances on Bloomberg TV and is a weekly contributor to TD Ameritrade Network’s “Morning Trade Live”. His main passion is making the complex world of options more understandable and therefore more useful to the day trader. Tim is the editor of POWR Options newsletter. Learn more about Tim’s background, including links to his latest articles.
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