Pair Trading Strategy Journal

My spreads in the energy sector are very volatile and currently at wide spreads, today was not nice, however if volatility subsides or we get a bounce in the markets they should tighten based on previous movements in the General Market. I'm currently working on new rules. I'm looking at the stocks I hold and what they did on previous big market move days and learning more & more how they react, I might start a database to record my findings.
 
Quote from jonnysharp:

Found a good site for Pair trading information, it's actually a page full of links.
http://finance.martinsewell.com/pairs-trading/

Has anyone used options for pair trading? like sell a put on the long stock & sell a call on the short stock, or buy a call & put?
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I mostly do iron condors and vertical spreads to offset risk. What you are talking about seems more like covered calls/puts or synthetic positioning which is ok but i have not found those strategies to be any better than buying or selling the actual stock. Covered calls/puts have their place but i like iron condors better because of the defined risk.
 
Quote from jonnysharp:

Found a good site for Pair trading information, it's actually a page full of links.
http://finance.martinsewell.com/pairs-trading/

Has anyone used options for pair trading? like sell a put on the long stock & sell a call on the short stock, or buy a call & put?
More...

Hey Johnny,

There are many option strategies to play spreads. The most applicable that compares to dollar neutral strategies is the straddle. Buying a call and a put at the same strike price at or near the money. The safest way to do this is to buy an expiration at least 4 months out. In addition use technicals such as bollinger bands and look for the bands to narrow. Narrow bands are usually a precurser to a breakout or breakdown.
 
Cointegration is the econometric tool used to measure reversion to the mean. It can be a complex idea for non statisticians. I have also read some stuff on Pearson Correlation which is a variation of standard corr. However, correlation is NOT the best measure IMO but obviously it works somewhat. Take a simple example:
1) Stock 1 @ 10, Stock 2 @ 10,
2) the next instance Stock 1 @ 50, Stock 2 @ 10,
3) next instance Stock1 @ 10, Stock 2 @10.

Correlations probably would be terrible but its great mean reversion. Very simple example.

Now honestly, I think you can mostly skip the entire correlation AND cointegration, who cares? You want to make money, just backtest historical pairs to see if is profitable. Since we are just extrapolating historical data in the future, IMHO a backtest of profitability is suitable enough.

What interests me is diversion trading, can someone give examples or a framework on divergent pairs that they trade? TY!

Edit:
Yobo,

Have you tested or traded option pairs, what was your experience on profitability/drawdowns. It seems you only bot options with low vol (hence constricting BBands)? Perhaps selling vol (sell call, sell put with Delta exposure in desired direction) would work well in a high vol environment?
 
thanks gehko & yobo, interesting views there.
knocks, funny you say that because I looked at co-integration, correlation, etc.....and came to same conclusion if the pair produces good profits historically then It must wiggle back and forth consistently, correlation is just a good tool to confirm there is a statistical relationship confirmed by fundamentals. However I incorprated a uptrending correlation chart into my signal filters, I find this reduces the downside risk of a trade, since a weakening relationship tends to lead to more divergence, most of my open trades showing losses were taken on strong downtrending correlation charts when I didn't have that filter.
 
Quote from jonnysharp:

thanks gehko & yobo, interesting views there.
knocks, funny you say that because I looked at co-integration, correlation, etc.....and came to same conclusion if the pair produces good profits historically then It must wiggle back and forth consistently, correlation is just a good tool to confirm there is a statistical relationship confirmed by fundamentals. However I incorprated a uptrending correlation chart into my signal filters, I find this reduces the downside risk of a trade, since a weakening relationship tends to lead to more divergence, most of my open trades showing losses were taken on strong downtrending correlation charts when I didn't have that filter.
More...

An informative and simple test would be to backtest your pairs using your correlation drift signal and only take the pair when it is drifting, stay out when not. Would be interesting to see if isolating trades to positive drift improve results in a highly successful pair and an average pair (reduce vol/higher profits)?
 
Another volatile day, VIX @ 35.

Closed 1 trade today for a nice profit;

Sold TOL @ 23.95
Covered PHM @ 14.37

One new trade today:

Long HNZ @ 51.03
Short GIS @ 69.92

Open trades: 11
Wins: 14
Losses: 0

I'm staying away from financials for the rest of the year at least and I'l probably stay away from the energy complex for awhile too. Volatilty and tail risk in these sectors are too high.
 

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