A pairs trading strategy with ETFs is something every trader can easily add to their playbook. Some use it as a way to limit risk when markets are volatile, and others use it as a hedge in case they’re wrong about a certain investment.
And I see quite the Money Link developing right now — in fact, we might strike oil with it…
It’s actually a popular pairs trade with ETFs that big banks, institutions and shrewd hedge funds have been sniffing around for awhile: crude oil and oil stocks.
Those who know me know that pairs trading is my love language — it’s how smart investors make money off the stock market no matter if it’s up or down.
A pairs trade is a strategy with matching long (bullish) and short (bearish) positions in two stocks that have a high correlation between them. Usually, you can spot a high correlation of money flowing out of one stock or fund and into the other.
We want to make sure what we’re seeing in the markets now is following a similar pattern from market moves in the past.
These two positions will then form the base of a hedging strategy that should benefit the buyer whether there’s a positive or negative trend in the stock market
And there’s a huge dislocation happening between oil and oil stocks that all investors need to be aware of…
How Investors Can Use a Pairs Trading Strategy with ETFs
Taking a look at a Crude Oil WTI Futures chart, you’ll see that it has broken over $70 a barrel for the first time in over five years.
And then if you compare this to how the Energy Select Sector SPDR Fund (NYSEArca: XLE) has been performing, you’ll understand why this is the perfect pairs trade for this summer.
The lag this ETF is showing on its five-year chart is incredible — in the worst way possible.
I have a gut feeling 2021 could become the summer of crude oil, with crazy inflationary moves in gas and energy.
It’ll definitely shock America and create economic havoc… but the stocks sure aren’t showing any of these warning signs to investors — yet.
Why?
Here’s what we know: Oil stocks have lagged actual crude oil by 40% this year…
But how long will this last? Typically, oil stocks get more expensive than actual oil during every boom, and I expect the same thing to happen this summer. For now, there’s a small window of time to take advantage of this institutional-style Money Link.
So let’s say we buy XLE CALLS and sell United States Oil ETF (NYSEArca: USO) PUTS… do you have any idea how far we can take this pairs trade?
Check out our short video below to learn more about using a pairs trading strategy with ETFs. Be sure to share your thoughts in the comments section below.
And as always, send any trading questions to jeff@joyofthetrade.com and stay ahead of the markets, especially these choppy ones, by subscribing to our YouTube channel.
P.S. Most people don’t know this but every Tuesday morning before the stock market opens, Wall Street tips its hand off to a number of stocks.
But the traders who catch it could lock in some serious paydays every week…
I’m talking about gains like 90% on RIOT… 104% on FSLR… 122% on MRNA… 147% on FCX… 232% on ORCL… and dozens more!
And it’s all done by placing a simple trade every Tuesday and closing it out on Friday…
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