Pair options trading was first introduced to the retail markets (the big boys on Wall Street have had access for many years) with the official launch of Stockpair in 2010. Since that time pair options trading has rapidly gained in popularity and mainstream acceptance by the trading community. A predictable result of this popularity with traders has been the spread of pairs trading software to beyond just the Stockpair platform. Many of the most popular binary options brokers have incorporated some pairs trading capability into their binary options platforms. However, the pair options offered by these brokers are a bit different from those offered by Stockpair. But we’ll cover all the varieties in this article so you’ll know what’s available out there.
Pair Options Trading Overview & Highlights
All varieties of pair options contracts at the various brokers share some fundamental characteristics which make them “pair options,” of course. So before getting to the specifics of each contract type let’s look at a general overview of what these instruments are all about.
Pairs trading is the simplest means of trading on the relative performance of a “pair” of underlying assets. Most often the “paired” assets will be similar or from the same sector, but not always. And, because it is only the relative performance that matters, pairs trading is a completely market neutral form of trading. Simply meaning that overall market conditions are irrelevant to the outcome of your trades. You can make money on up or down markets with equal ease, it makes no difference. That’s pairs trading in a nutshell, but don’t worry we’ll be going a bit deeper than that. But first some highlights…
- Entirely Market Neutral Instruments
- High Returns Of Up To 350% Per Trade
- Precise Risk Management
- Extremely Simple To Learn & Trade
- Great For Hedging Other Instruments
- Simple “Standard Deviation” Pairs Trading Strategies
- Smaller Than Usual Drawdowns
I think that those are probably the main and most important highlights of pair options trading. Certainly there are others, but you will discover them on your own easily enough if you decide to try pairs trading. And some will apply more to one variety of pair options contract than another, so you’ll have to play around a bit. Because they are the simplest form we’ll first go over the type of pairs trading that you will find at brokers that specialize in binary options. That is, everyone besides Stockpair.
The first two images in this article were taken from two of our personal binary options trading accounts, at Traderush and GOptions. As you can see from the images, both brokers treat their pair options contracts just like their standard high/low binary options contracts. And this is true across all the binary options brokers that currently offer some pairs trading capability. This is very similar to, but not exactly like the “Fixed” variety of pair options offered by Stockpair, which we’ll get to in just a second. They really need no further explanation since they are exactly the same as a forex binary options trade, except with a variety of paired underlying assets besides currencies.
Pair Options Trading At Stockpair
Stockpair, as the name implies, specializes in pairs trading, and was the first to bring it to a wider audience. As such they have a unique and proprietary trading platform that was built around the idea of pair options, while handling binary options just as well. Stockpair is the undisputed king of pair options trading and they do it extremely well indeed. Unfortunately, they no longer accept US traders so if that’s you, you’ll have to be satisfied with the simpler pairs trading at your binary broker.
Fixed Pair Options At Stockpair
As we mentioned earlier, the fixed variety of pair options are very similar to the standard high/low binary option contract. Which is why binary brokers were able to incorporate at least limited pairs trading into their platforms. Nevertheless, Stockpair still does it better and they are a little different, so let’s take a closer look.
As you can see there is a lot more asset variety, features, and trading options than the “plain” pairs offered by brokers specializing in binary options. They also offer a much better expiry selection, ranging from 5 minutes all the way up to 150 days! They generally offer higher return rates on their fixed pairs than the other brokers as well, but not always, or on all assets. With these contracts, just like with high/low binary options, performance is measured only from the time of purchase forward, until expiry. Let’s look at a quick fixed pairs trading example.
Fixed Pair Option Example Trade
Using the stocks from the image above, let’s assume that our hypothetical trader believes that Google, who announces earnings at the end of the week, is likely to perform better than Facebook over the next two weeks of trading. Nothing that has taken place before now matters to our trade. As soon as we purchase our “put” fixed pair option on the FB/GOOG pair (meaning FB performs worse than GOOG over the chosen period) their performances are set equal to each other.
1) Purchase of Put Fixed Pair Option for $100 on FB/GOOG pair
2) Fixed Pair Offering Returns of 84%
3) Performances Are Reset By Stockpair To Equal 0.00%
Now let us further assume that our hypothetical trader was correct, and after announcing a positive earnings beat after markets close on Friday, Google stock soars during Monday’s trading. Fast forwarding to the end of our two-week expiry window we have the following results.
1) Facebook Stock Has Gained 1.73% From Time of Purchase to Expiry
2) Google Stock Has Gained 2.32% From Time of Purchase to Expiry
3) Meaning Google Outperformed Facebook by 0.59% Over the Period
4) Which in Turn Means the Trade Finishes ITM For a $184 Return
Floating Pair Options At Stockpair
Floating pair options are only available at Stockpair for the time being, and are the more “exotic” of the two contracts. And these are also the instruments that can offer returns anywhere from just a few percent, all the way on up to over 350% in some cases. There is a lot of flexibility and room for strategy development with these options. They are what made Stockpair a star originally.
With floating pair options contracts, performance is measured over a fixed period of time, not reset at the time of purchase. This allows for “floating” return rates that fluctuate with the difference between the two assets’ performances. Which sounds more complicated than it is. These contracts are only available with three expiry windows: a day, a week, and a month. Performance is measured over the whole of those periods, and therefore divergences can grow quite wide.
Floating Pair Option Example Trade
Once again we’ll use the trade image above for our example to keep things simple. In this example the expiry window for the floating trade is one day, and this shows a couple of hours into the day. At this point RIO had performed significantly better so far that day, and therefore had a much better chance of finishing the day as the dominant performer. Our hypothetical trader believes that RIO is almost certain to maintain its lead throughout the day, and is happy to take an easy 27% return. Not bad for such a “sure thing.”
1) Prior To Purchase BHP Had Lost 0.73% So Far That Day
2) Prior To Purchase RIO Had Lost 0.26% So Far That Day
3) So RIO Had OutPerformed BHP by +0.47% So Far That Day
So, for our newly opened trade which expires at the end of the day to finish as a loser, BHP would need to outperform RIO by 0.48% over the course of the rest of the day. Certainly possible, but unlikely given the circumstances. And in fact our trader was correct, BHP did not rally to overtake RIO in the last half of the day, and the trade finished solidly ITM for a 27% payout, or a return of $127 on our $100 investment. Not a huge gain, but pretty good for such a high-probability trade. It is that kind of flexibility that makes these options so useful and fun to trade.
Well, that’s pretty much it for the introduction to pair options trading. We will also be publishing some more in-depth strategy material for pairs trading in the near future, so stay tuned for that. We have really enjoyed pair options ever since we first tried them while doing a review on Stockpair several years ago. Unfortunately, as US traders ourselves we can no longer trade at Stockpair, but the rest of the world is still in luck. And for those of us that are based in the US, well we still have the pairs offered by our binary brokers, which is better than nothing.