Today, we check out a "pairs trade" that worked out beautifully.A pairs trade is a two-sided position often used by professional traders. On one side, they purchase a stock, betting it will rise. On the other side, they sell as stock short, betting the price will fall. Pros use pairs trades to profit from the diverging fortunes of particular businesses. Take the Blockbuster/Netflix trade...
For many years, Blockbuster was just about the only game in town for movie rentals. But about 10 years ago, mail-order company Netflix began offering folks a way to rent movies without due dates, late fees, and trips to the strip mall. "On demand" cable offered a similar hassle-free service. As you can see from today's chart, the market likes the hassle-free method a lot better.
Netflix went public in 2002. Shares are up nearly 600% since then. Blockbuster shares are down about 94% in the same time. The chart below shows the two share prices plotted against each other since 2002. The wild divergence in share performance produced a steady, upward sloping "ratio" line. Tomorrow, we'll show you one pairs trade working right now... that will keep working for years.
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