A lot of times when doing technical analysis traders try and eliminate market forces and market sympathy from being factored into their decision of what and where to trade. When you eliminate this part of the analysis of the equation, you are said to be trading a market neutral strategy. One great strategy that attempts to do this is called Pair Options Trading.
Pair Options Trading is based on the theory that certain assets have shown over time to have their price move very close to the same length over the same time frame as another asset; this is called correlation of the pairs.
The relative amount of correlation between two pairs when it comes to trading is addressed as a percentage. Of course the ideal correlation between the movements of two assets is 100%, but unfortunately you will never see this. 100% correlation means as one asset moves over time up or down in price, so its pair moves ‘exactly’ the same. Of course at the opposite end of the spectrum there can be zero correlation between asset pairs if they move in opposite directions all the time.
Why is correlation a useful parameter on which to base a trade on? The answer is because it has a predictive nature to it when analyzing and monitoring favorable factors for placing a trade. Two assets that often correlate together send a strong signal to place a trade when one starts to deviate from the other.
This market neutral strategy, pair options, seeks to fully capture all the benefits that close correlation has to offer. When investors see a break in the movement of two highly correlated assets, they can place both a put option on one asset and a call option on the other asset at the same time.
Chances are that atleast one of the trades will be profitable for them if they do this. One nice thing about pair options is they can be profitable regardless which direction the market is trending in. Many trading sites allow you to select assets that can be tracked according to the correlation between them. Analysis of this can directly lead to finding profitable trading opportunities.
In case you were wondering, the entire concept of pair option trading is not a new concept by any means. It has been used by traders as a market neutral strategy for many years because it has proven to be reliable and effective. Many closely related strategies have been formed from using the basic premise of pair options strategy too. A trading website called Banc de Binary, was the first to introduce it for use in online trading in 2009; this made this type of correlative information available to everyone, not just big professional investment firms.
So now that this information is available and ready to use, take some time to examine it. If you read more on the subject of pair options trading, you will see that the correlation between many pairs has already been figured out for you. That should make it easy for you to spot the uncorrelated movement between the pairs and place your profitable put and call options exactly where they need to be.
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