Spread Betting Strategies
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Pairs Trading
This strategy involves trading two companies in the same sector. In order to profit, pair traders buy the stronger company and sell the weaker if they think the sector is gaining strength. They do the opposite if they believe the sector will fall.
The idea is that if the market believes that a sector is worth more, pairs traders will usually buy more of the stronger company than the weaker. Traders hope that the spread betting companies will underestimate the rise in price of the strong company and overestimate the rise in price of the less strong company. This will mean that the trader will win both bets and make more profit than if they had just bet on one of the companies.
To further understand the strategy of pairs trading, please read the following example:
Suppose that investor A has been researching the telecommunications sector lately and sees very strong prospects for growth. He researches further and discovers that spread betting companies agree with him and have set very high spreads on all the stocks.
Realising that the news is beginning to spread that the telecommunications sector is undervalued, investor A decides to make a pair trade spread bet. He buys the spread on Vodafone, one of the strongest companies in the sector, which is spread at 250p-260p and sells the spread on Plusnet, set at 80p-90p, which is a smaller company that investor A believes is less strong in the sector.
It turns out that when investors bought into the sector, the majority of them went for the stronger companies and few bought the smaller market capitalisation companies. The Spread betting company did not foresee this and underestimated the gain that the Vodafone would achieve and overestimated the gain that Plusnet would achieve. In the end of the run, Vodafone sat at 265p and Plusnet lingered at 73p.
Therefore both spreads were off target and investor A profits on both of his spread bets.
