A pair trade is a market neutral trade, were you are speculating on the relative value of one stock to another. There are several ways to find market neutral trades, and one of the best is to find a mis-valued pair trade where the companies are in the same sector.
BB&T Corp (NYSE:BBT) has declined relative to Prudential (LON:PRU). During the past 3-years the ratio of the two companies share prices has stretched to 2.5 standard devations from the 100-day moving average, generating an opportunity to purchase one stock and short the other.
This has happened 6-times over the past 3-years and in all-six occasions, the ratio between BB&T and Prudential has reverted back to the mean.
There are multiple ways that you can take a position where you buy BBT and Sell PRU. The most common would be to purchase BBT and Short sell PRU. The ratio is approximately 0.42, so you want to short 42 PRU for Every 100 BBT you purchase
You can also ;use options to take a position, there are website such as Optionwisdom that describe how to use options to generate a pair spread.
For example, you can purchase the BB&T April 21, $46 call and sell the PRU April 21, $110 call for a net credit of $0.10. This position makes money if the ratio of the prices remains unchanged or moves in favor of BB&T. Both strikes are 5% out of the money.
Example
Purchase BBT April 21, 2017 $46 call for $0.30 (5*$0.30 = $1.50)
Sell PRU April 21, 2017 $110 for $0.80 (2*80 = $1.60)
You want to use the ratio of approximately 42%.
So you purchase 5 BBT calls for every 2 PRU Calls, for a net debit of $0.10.
The benefit of trading the options position is that if the prices of both shares move lower you make money, and if they both rise, you are positioned to take advantage if BBT outperforms PRU.
