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Pairing Up for Profit

To keep the dollar amount invested in the pair, one would buy at least three Gateway calls for every one Dell put purchased. The position makes money if the price spread between the two stocks converges over the next 14 months. The maximum loss is equal to the total cost of purchase of both the puts and calls.

Another possible pair involves going long the International Securities Exchange (ISE) and short the Chicago Mercantile (CME - Get Report). The ISE is the leading options exchange, and with option volume growing at nearly 50% year over year, faster than any other trading product, the ISE's revenue and profit growth should outpace that of the CME in the coming year. The ISE shares are trading around $28, while the CME is around $388 per share. So in this case, one would purchase ISE calls and CME puts on approximately a 13-to-1 ratio.

Remember, paired trades require one to be right on two stocks, not just one, but options can expand the range in which you can be wrong and still make money.

Steven Smith writes regularly for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He was a seatholding member of the Chicago Board of Trade (CBOT) and the Chicago Board Options Exchange (CBOE) from May 1989 to August 1995. During that six-year period, he traded multiple markets for his own personal account and acted as an executing broker for third-party accounts. He appreciates your feedback; click here to send him an email.

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