Avoiding rotten luck trading pairs
PICKING out individual stocks from a sector can be a tricky business. Even if you think that a particular equity is ripe for the picking, it could be dragged down by a fall in the sector as a whole. This is where pairs trading can come in to help you. “Pairs trading is an often overlooked strategy in favour of taking one-way directional bets,” says Manoj Ladwa, senior trader at ETX Capital. “Pairs trading allows the trader to hedge and reduce risk by going short and taking out a trade in the opposite direction.” He points to a strategy of going long on Shire Pharma and short AstraZeneca – both competing in the same sector but with differing fortunes over the last month (see charts, below.) Should the pharma sector take a tumble, you would be hedged against the fall – the thing that would matter would be the relative performance of Shire Pharma against AstraZeneca. Similarly, you can also take a position on two equities from two different sectors – one cyclical and one anti-cyclical – again relying on their relative performance.
PAIR PICKING PROBLEMS
When it comes to pairs trading with spread betting, there are a couple of things to be careful of. Ian O’Sullivan, head of sales for SpreadCo, points out you might have to hold a position for days, if not weeks, for the spread to come back in to line and allow you to trade out – this can lead to expensive financing costs to hold the position open. As such you should look to whether your spread bet provider charges you to be short overnight – if not, you only need to pay the financing on the long side of the pairs trade. According to O’Sullivan, you should also look to avoid getting stopped out on one side if things move rapidly, but not being able to close the other side of the trade on time or at a price that means you actually make a profit on the trade. “Of course the other problem you could face is a sudden event such as a takeover announcement, profits warning, senior executives leaving for a rival which can blow even the most carefully planned pairs trade out of the water,” says O’Sullivan. “But if you can watch for opportunities and get in and get out when the time is right, pairs trading can be a nice little earner with reduced risk compared to taking an outright position on one side or the other.”
oyi has been unable to bring the share price back to it’s glory days. Capital Spreads quotes PepsiCo 63.13 – 63.22.
Many investors would say the 61 per cent drop in Home Retails profits has already been factored into the stocks price, so could there be any further damage to its shareholder’s pockets after the Full Year Trading Update on Thursday, with speculation over a dropped final dividend shaking the nerves of its followers. Capital Spreads quotes a price of 103.2 – 103.8.
The Brazilian Bovespa has been slowly but surely clawing itself back towards its highs so far this year, adding to the double digit percentage gains so far this year. Despite the surprise fall in GDP by more than expected last week the bulls still seem to be in control. Capital Spreads offers an April contract with a price of 67145-67205.
Ongoing fears of conflict in the Persian Gulf continue to affect the oil price, and investors are starting to look around for companies who will not be greatly at risk from any US-Iranian spat. Tullow’s African focus means it will be relatively immune, although fears have persisted about the value of its flagship fields off the Ghanaian coast. A fairly upbeat comment from Tullow about production prospects could help the shares to recover some of the ground lost in late February, as the effect of reduced output forecasts took hold. IG Index’s price on Tullow is 1433/1437.