Pairs Trading with Options

G

granville

Hi All,

I'm considering trading a few stock pairs (long one, short the other) but find that this strategy requires significant capital or lots of leverage to get decent returns.

I'd like to try leveraging up with options. Rather than hold a stock for a few days, I would hold an option on the stock.

Any suggestions? Has anyone tried this? An ideally contructed position would move exactly like the underlying, be liquid and have low speads. But options are tricky things....

Thanks,
Granville
 
thinkorswim have done a few seminars on the top of pairs trading with options e.g.: http://mediaserver.thinkorswim.com/transcripts/June_21_2006_pairs_trading.pdf

Though I believe option positions are used for limited risk purposes rather than leverage.

The last thread that attempted to discuss this topic (exact same title) didn't last very long despite efforts to revive it:

Pairs Trading with Options

There is a new book out (Jan 06):

The Handbook of Pairs Trading: Strategies Using Equities, Options, & Futures

As per the title, it covers some pairs trading with options. I have not read it yet.

Good luck!

MoMoney.
 
Good to know. Care to cite any reasons? What is your take on Vidjamurthy's Pairs Trading so that I can calibrate my opinion with yours.

MoMoney.

Quote from segv:

This is a terrible book - do not waste your money.

-segv
More...
 
Quote from momoneythansens:

Good to know. Care to cite any reasons? What is your take on Vidjamurthy's Pairs Trading so that I can calibrate my opinion with yours.

MoMoney.
More...

The book "The Handbook of Pairs Trading" is innacurate, incomplete, vauge, poorly written, and ultimately fails to define a pairs trading strategy. The first three chapters are a bad summary of fundamental analysis, technical analysis, market-neutral invsting, and arbitrage. The author then presents his "Unified Theory", where he begins, "The pairs trading investment strategy is comprised of three central elements: the market-neutral element, the arbitrage element, and the technical analysis element". He then proceeds with Chapter 9, titled "Reviewing the Elements", which is unbelievably, an even-worse summary of the preceeding 8 chapters. The final section of the book, "Advanced Strategies and Examples", still fails to present a strategy for pairs selection or trading. Instead, it presents more tertiary review of basic finance knowledge, such as "The purchase of call option is the most basic strategy in options trading". This book is full of filler; yet another worthless volume in the long line of so-called finance books published by John Wiley and Sons.

It is amazing to me that that the same company can at the same time publish a book like "Pairs Trading", by Ganapathy Vidyamurthy. I consider Vidyamurthy's book the best published texts on pairs trading. Unlike Erhman's book, Vidyamurthy's started as a PhD thesis. Readers without a quantitative or scientific background will not find Vidyamurthy's book helpful. However, as pairs trading is inherently a quantitative strategy, the book is well suited to the target audience and is an excellent introductory text on the subject.

-segv
 
Quote from segv:

The book "The Handbook of Pairs Trading" is...

-segv
More...

Thank you for the excellent synopsis. I will be giving it a miss!

Agree on Vidyamurthy's volume. I think even those without quantitative or scientific backgrounds can glean some useful information with perseverance but you're right about the target audience.

MoMoney.
 
Quote from granville:

...move exactly like the underlying, be liquid and have low speads...
More...

That's pretty much the exact opposite of what options are!:D

Moving exactly like the underlying is synthetic stock, but you're generally better off just going with the actual stock. Liquidity is a significant problem and so are the spreads, unless you're talking about ETFs like SPY, QQQQ in IWM and even then the minimum spread is 0.05.
 
there are tons of conditions on what your saying... basically options not only limit your risk but they as well provide leverage.. i'm going to read that book.. i've been doing alot of reading on this subject and wanna know alot more..just to learn really.. and hopefully eventually make some money on some mispricing..

this thread.. toward the end is turning into a pairs trade analysis on HOT and HST

http://www.elitetrader.com/vb/showthread.php?s=&threadid=237628&perpage=6&pagenumber=44
 
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