Pair Strategy And A Bit Of Luck

I have got lots of attention on my pair strategy lesson and the play I took in both Apple and Research In Motion. I went long Apple and short Research In Motion.

The tactic of matching a long position with a short position in two stocks of the same sector is called pair trading. This creates a hedge against the industry and the general market that the two stocks are trading in. The hedge made is really a gamble that you are placing on the two stocks; the stock you are long in against the stock you are short in.

As its name implies, a pair trading approach is a dual-pronged strategy, where 2 outwardly contrasting option or stock trades are entered simultaneously. The tactic can offer somewhat of a safety net to guard against an unforeseen move in a particular sector, while capitalizing on a specific equity's relative-strength backdrop.

Fundamentally, a pair trader hedges his or her bets, opening positions in 2 interrelated equities or indexes and working them against one another, selecting 1 call (bullish) position and 1 put (bearish) position. The pair of positions then collectively enables money-making returns among a number of outcomes.

For example, I had a great point of view about Apple, but a pessimistic feeling about Research In Motion. I went long on Apple while I shorted Research In Motion.

I also had an uneasy sentiment concerning the whole tech sector. Through taking a short position in Research In Motion, it permitted me to profit if a large sell off in tech happened. This profit on the short side would counteract my losses in Apple on the long side.

Apple maintained its relative strength versus Research In Motion. The shares rallied and the short side of the trade (Research In Motion) fell. Both sides of the paired trade entered positive territory.

But let's say the entire technology sector suffers a large decline. The Research In Motion short is profitable, counter-acting the Apple long position which nets a loss. This is a better outcome than if I only went long on Apple.

You are looking for the percentage change in the market between Apple and Research In Motion to go in Apple's favor no matter what direction Apple or Research In Motion head.

On May 14, 2009, I went long Apple at 122, and short Research In Motion at 71. I closed out the pair on July 10th 2009 with Apple at 137 and Research In Motion at 66. I made 12% on my Apple long, and 7% on my Research In Motion short. So the total gain was 19%.