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Pairs Trading 23 rd October 2013

Pairs Trading 23 rd October 2013. Presentation. Derek Crookes: Basic introduction to pairs Trading Jonathan Roche: Highlights of a Pairs Trading Case Study Searching for pairs – some tools and methodologies Tracking Pairs – what is involved

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Pairs Trading 23 rd October 2013

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  1. Pairs Trading23rd October 2013 www.pairstrading.co.za

  2. Presentation • Derek Crookes: • Basic introduction to pairs Trading • Jonathan Roche: • Highlights of a Pairs Trading Case Study • Searching for pairs – some tools and methodologies • Tracking Pairs – what is involved • Thoughts on what one needs to trade pairs successfully www.pairstrading.co.za

  3. Risk Warning • Trading is risky • This may not be suitable for you • It is your responsibility what you decide to do with your trading • SO this presentation does not contain nor should be construed as investment advice or an investment recommendation www.pairstrading.co.za

  4. History • ‘Pairs Trading’ is an investment strategy used by many Hedge Funds. • Pairs trading or statistical arbitrage was first developed and put into practice by NunzioTartaglia, while working for Morgan Stanley in the 1980s. • Pairs trading was one of the most profitable strategies that was developed by his team which gradually spread to other firms. www.pairstrading.co.za

  5. Pair trade strategies & terminology • Asset Arbitrage • Merger Arbitrage • Spread Trades • Spread Inversion • Double Alpha Trades • Differential • Risk Arbitrage • Co-Integration • Correlation • Ratios • Relative value • Co-Variance • Mean Reverting – return to the Average www.pairstrading.co.za

  6. Books • Trading Pairs – Mark Whistler • Statistical Arbitrage – Andrew Pole • Pairs Trading – GanapathyVidyamurthy • 3rd Party Price feed into excel • Don’t rely on statistics, or patterns etc, only www.pairstrading.co.za

  7. What is a pairs trade • The general 'rule of thumb' is to sell overvalued securities and buy undervalued ones. • It is only possible to determine that a security is overvalued or undervalued if the true value of the security is known. • Pairs trading is about relative pricing, so that the true value of the security is not important. • Relative pricing is based on the idea that securities with similar characteristics should be priced more or less the same. • When prices of two similar securities are different, one security is overpriced with respect to its 'true value' or the other one under-priced or both. www.pairstrading.co.za

  8. What is a pairs trade continued • Long 1 stock and short another stock, generally in the same sector • Eg. IMP vs AMS (Mining – Platinum) • Why do we do this – Trade a Pair? • Reason: • Are you able to determine when the market is going up/down? • Determine a mispricing between 2 securities • to reduce your risk, this is not risk free www.pairstrading.co.za

  9. How to determine a pair • Same sector instruments • Quick eye ball – overlay the instruments return over the last year or 2 • Calculate the relative value – divide the 2 instruments closing prices • Calculate average to determine the relative value(ratio) to the mean – looking at convergence, divergence • What MA do we use? • Determine Std Deviation to enter into a trade with the highest probability of a positive return – Mispricing opportunity • Determine the strategy www.pairstrading.co.za

  10. Calculate a Pair position • Long Ned vsShortStd Bank • Both instruments must have the same notional value • Notional value / price = shares • Ned: 100 000 / 195.00 = 513 (rounded) • Sbk: 100 000 / 124.00 = 806 (rounded) • Nedbank price increases to 211.00 • Sbk price increases to 127.00 www.pairstrading.co.za

  11. Calculate a Pair profitability • Margin – 10%(R10 000) • ROWC – 50% rounded www.pairstrading.co.za

  12. Performance graph – IMP vs AMS (500 Trading days) www.pairstrading.co.za

  13. Relative graph – IMP vs AMS +-25 www.pairstrading.co.za

  14. Relative graph – IMP vs AMS +-20 www.pairstrading.co.za

  15. Relative graph – IMP vs AMS +-12 www.pairstrading.co.za

  16. Relative graph – IMP vs AMS +-10 www.pairstrading.co.za

  17. Performance graph – INL vsINP (500 Trading days) www.pairstrading.co.za

  18. Relative graph – INL vsINP www.pairstrading.co.za

  19. Pair Performance– INL vsINP www.pairstrading.co.za

  20. Relative graph – INL vsINP www.pairstrading.co.za

  21. Pair Performance– INL vsINP www.pairstrading.co.za

  22. Performance graph – NED vsFSR (500 Trading days) www.pairstrading.co.za

  23. Relative graph – NED vs FSR www.pairstrading.co.za

  24. Relative graph with StdDevNED vs FSR www.pairstrading.co.za

  25. Pair Performance– NED vs FSR www.pairstrading.co.za

  26. Pairs Ratios / Relative www.pairstrading.co.za

  27. Marker www.pairstrading.co.za

  28. Jonathan Roche • Trading for 10 years • 4 Children and Wife • BscMechEng • MBA • U of CT • This is all he does! www.pairstrading.co.za

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