Are interest rates and spread risk in the yield curve making you sweat what your next move in the market should be? Relax. Spread your risk in financial service providers PayPal (NASDAQ:PYPL) and Discover (NYSE:DFS) using a well-placed pairs trade in PYPL stock and shares of DFS.
Let me explain.
It has been a tough environment for financial stocks of late. That’s not to say it has been rainbows and puppy dogs for investing in other sectors. It hasn’t of course. Still, the market’s obsession with pricing in the possibility of a recession and flattening the yield curve has hit names like Bank of America (NYSE:BAC) or a JPMorgan (NYSE:JPM) harder than the broader market.
But that’s not to say the financial sector is a bearishly level playing field either. It isn’t. Furthermore, investor sentiment regarding the economy and/or interest rate policy and spread risk between short and long-term rates can abruptly stop on a dime. So, what’s a trader to do and what’s that have to do with PYPL stock and DFS?
The good news is uncertainty in the market and what may or may not happen with interest rates can work to the advantage of traders spreading their risk with a pairs strategy in PayPal and Discover stock because we don’t need to be 100% right.
Ideally, profits can be extracted from both the bullish and bearish position. But, even if we’re only half-right, the spread combination can ring the register. What’s more, the pairs position in this scenario could even turn into a bigger winner. So, now the question is what to do with PYPL stock and DFS stock?
Pairs Stock Strategy Long: PYPL Stock
So, why is PYPL stock a buy? Despite the bearish headwinds, which have plagued many financial companies, shares of PayPal have performed terrifically. In fact, PYPL hasn’t just outperformed its peers. With year-to-date gains of nearly 18%, that’s obvious to any investor with even a passing interest in the market.
But if we take a look at PayPal’s stock chart, it’s not hard to fathom the best may be yet to come.
The weekly chart of PYPL stock shows a stock that has already come a long way from its debut a couple years back. But gains of nearly 130% over the past three-plus years have also gone absolutely nowhere for the past ten months.
Now this zig-zagging period of consolidation or what some might label as a base-on-base double-bottom pattern is ripe for an upside breakout. Shares of PYPL are already narrowly above January’s high, which marks the beginning of the base formation. That’s bullish in of itself. But I’d like to see just a tiny bit more price confirmation.
For going long PayPal as part of this pairs trade with DFS, my focus is on purchasing PYPL stock above the pattern mid-pivot of $89.06. That should lead to a successful breakout to fresh all-time-highs and continued relative strength without (hopefully) entering prematurely. Having said that and with no guarantees of how PayPal plays out, I’d initially set a stop 8% beneath the purchase price.
Pairs Stock Strategy Short: DFS Stock
I have a Discover card, but unlike PayPal, which I use all the time, I barely use it. I’m also not a buyer of the company’s “faster cashback” shtick in its irritating twins-based commercial campaign. In fact, I’m a seller of that marketing scheme and would tell the ad agency responsible for it, “You’re fired!” So, maybe that’s why I see DFS stock as a short? It could be, but the chart doesn’t hurt either.
Similar to PYPL stock, shares of Discover were doing a lot of things right on the price chart in 2018. DFS stock had been establishing a base-on-base double-bottom pattern just like PayPal. What’s more, the formation was actually even stronger given the relative positioning of the W-shaped base relative to Discover’s 2017 high.
But charts can and do change. And sometimes it’s not for the better. After failing to make good on the promise of a breakout to fresh all-time highs, DFS stock has gone on to break down from a bearish flag set against key resistance defined by the former high and a weekly uptrend line.
The other reality is today’s bearish-sounding situation, much like PYPL stock, is DFS stock is still in a larger uptrend. Furthermore, and as I sometimes like to jokingly state, “there’s always a line somewhere.”
On the DFS price chart a couple of important lines that are “somewhere” nearby are the 50% and 62% retracement levels and 200-week simple moving average. Along with our alternative way to look at DFS stock’s uptrend, things appear potentially a bit less threatening for bulls.
Nevertheless, I’m more or less bearish on DFS’ prospects relative to PYPL stock or at least I see the shares under-performing in a bullish environment. Having said that, I’d wait to enter short on a pullback toward pattern resistance if PayPal breaks out.
I’m guessing going long PYPL stock and going short DFS stock for a more dearly held price will align nicely. As with buying PayPal though, a stop-loss to manage risk is smart business. Ultimately, this allows our winners to run and keeps our losses under tighter management for the other, and some might say better, half of this pairs strategy.
Disclosure: Investment accounts under Christopher Tyler’s management do not currently own positions in any securities mentioned in this article. The information offered is based upon Christopher Tyler’s observations and strictly intended for educational purposes only; the use of which is the responsibility of the individual. For additional options-based strategies, related musings or to ask a question, you can find and follow Chris on Twitter @Options_CAT and StockTwits.
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