An interesting variation on classic binary options is a relative new type of contract known as a pair option. Pairs trading is not offered by all brokers, but traders will find that it is a form of investment product that is being increasingly made available to interested investors. In this article we seek to examine what these instruments are all about and how they can fit into an individual’s overall activity in the financial markets.
The Basics
Pairs are essentially a form of classic binary options that enable investors to speculate with respect to the performance to two underlying asset prices over a pre-defined period of time. Typically the underlying assets made available by brokers for this type of investing belong to the same sector, or two very similar sectors. Common examples underlying assets available for this type of instrument would be Coke and Pepsi, or BHP Billiton and Anglo American, or Apple and Google, or Intel and AMD.
The Objective
Investors who seek to use these products to generate substantial products need to focus on the underlying objective: correctly predicting which of the two underlying assets, which together constitute the ‘pair’, will perform better over the period of the contract. Typically the contract length for this type of instrument ranges from 1 hour to several weeks (or months).
People who succeed in correctly predicting which of the two assets will performed better at the time of the contract’s expiry will generate substantial returns, typically in the order of 85% (though returns vary from contract to contract and from broker to broker).
Advantages of trading pairs
Pairs are an effective instrument for investors who have, through extensive research, formed a strong view with respect to the future prospects of both underlying assets on a relative basis. If, for example, you have information that has led you to believe that Company ABC’s stock will over the life of the contract appreciate more than Company XYZ’s stock, due to your expectation that Company ABC’s earnings will be analysts’ forecasts while Company XYZ will fall short of analysts’ forecasts, you may have found a good opportunity to engage in a trade that involves both companies ABC and XYZ as underlying assets.
Another advantage of this form of investment is the fact that it can serve as an entertaining form of investment for people who are relatively new to the markets. Essentially, this form of investing can be thought of as a ‘race’ between two asset prices. For this reason pairs can provide a understandable and fun way for individuals to gain some initial exposure to the market.
Concluding remarks
This form of financial instrument can provide you with all kinds of opportunities for generating profits. Although they are particularly well-suited to occasions in which an individual has a strong view regarding the near-term relative performance of two underlying assets, pairs can also be an engaging and straightforward way for investors who are just starting out to gain some exposure to how the options market works.
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