2

PAIR TRADING – Gold/Oil Ratio

Recently I located an unusual stock trading strategy that involves “trading pairs”. Forex users trade pairs when it comes to currencies, now stock investors can do the same with commodities using the Pair Trading strategy.

Over the last thirty years it has taken on average 17 barrels of oil to buy one ounce of gold. When ever this number gets out of align, there is a chance to make money.

What You'll Need To Trade This Strategy

Note: If you can trade options, you can use ERX to go long on oil. ERY to go short on OIL. UGLD to go long on gold and DGLD to go short on gold.

How To Use The Strategy

Take the price of an ounce of gold and divide it by the price of one barrel of oil. If the number if lower than $17, that tells us the price of gold has to rise and/or the price per barrel of oil will fall until the average is once again achieved.

Let’s go back in history to see how this works. On September 1st, 2009 oil was $73.02 per barrel and gold was 955.20 per ounce. Now we take the price of gold, $955.20 and divide it by $73.02 giving us an average of $13.08.

The average of 13.08 barrels to buy one ounce of gold is telling us that Gold has to rise and/or Oil has to fall in order to go from $13.08 to $17.

Now that we know gold is going up and oil is going down we buy a Call on Gold and buy a Put on Oil at the same time. To buy these options we need stock symbols to work with so we use GLD for Gold and USO for Oil.

Since you don’t know how long it will take the pair to go from $13.08 to $17.00 I suggest you buy options that expire in six to 12 months.

Conclusion

Using this strategy I was able to make 43% in one week. Another time I made 96% in one month, and the best one ever was 143% in three weeks.

Today we see the Gold/Oil ratio sitting at around 29 and it was at a high of 43 (see chart below) not that long ago.

pairtrade

To see the Gold/Oil ratio so far out of wack is extremely rare and signals a collapse in the economy.

While this strategy has not worked for some time and has not profitable for years, we can still use the info as a signal of an impending collapse in the economy and buy puts on leading stocks.

For a trading strategy that does work when markets crash check out my Index Trading Strategy.

Click Here to Leave a Comment Below 2 comments