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Spread / Pairs Trading - the allure and the reality
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Spread / Pairs Trading - the allure and the reality

  #61 (permalink)
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josh View Post
ES/NQ sim trade is now $5800 in profit.

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The ES leg is actually in profit, with NQ staying very strong. First circle is the spread where the trade was entered, second is current. A two week sim trade may not be too exciting for some people, but this has demonstrated how the trade works at least, which was the only purpose.

Excellent!

Well done Josh. Get a few more of these under your belt and you'll be ready to go. Wait for a few losses to come in first though. I dont mean that in a negative way - but as we know, learning how to take a loss is key in this business.

Given the lower risk you're taking as a spread, the higher propensity for the spread to move - probably down to cyclical factors, and the lower margin, you see how spreads can be a good money machine.

FYI the 180 day correlation is 96, 30 day is 94 - some may say thats too high, but you're making money. It's best to stick to higly correlated pairs to start off - but remember I dont have too much experience trading inter commodity spreads. May be as correlation is declinig in the short term, thats where you're edge is?

Out of curiosity I wonder what a fly would look like consisting of es-nq spread against an nq-ym spread?

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  #62 (permalink)
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josh View Post
As a quick update--the sim trade initiated here is currently in profit $2740.

NQ profit = (3222.50 - 3160.80) * 4 * $20 = + $4936
ES loss = (1690 - 1704.50) * 3 * $50 = - $2175

Net profit = $4936 - $2175 - comms ~= + $2740

The DJIA has been so weak relatively that a short there instead of ES would actually almost be yielding a profit, or at least breaking even, so you'd have an NQ long free and clear for a $4900 profit.

Josh, you might find this short vid from Tom Sosnoff of interest. From about 15min in there's an example with MA and V, but the rationale behind AAPL vs QQQ (= 1NQ) is worth considering.

https://www.tastytrade.com/tt/shows/MT/episodes/1337

SS

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  #63 (permalink)
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TheDude View Post
Out of curiosity I wonder what a fly would look like consisting of es-nq spread against an nq-ym spread?

Thanks for the encouragement and info @TheDude . Do you mean to short the ES-NQ spread as I did here and then buy the NQ-YM? If that's what you mean, it would be doing damn well right now. Russell and Nasdaq have been super strong in the last 2 weeks, relative to the S&P which has been flat to down, and the Dow has just been a dog and has been particularly weak since the 9/18 high.

I thought a fly was usually constructed such that one product was hit twice, and the other two were bought once. So for example, buy the NQ/YM and sell the YM/TF (or YM/ES even). This way you sell YM on both legs, buy NQ on the first leg, and buy TF or ES on the second leg. Is this what you were referring to, or am I way off?

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  #64 (permalink)
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SisyphusStone View Post
Josh, you might find this short vid from Tom Sosnoff of interest. From about 15min in there's an example with MA and V, but the rationale behind AAPL vs QQQ (= 1NQ) is worth considering.

https://www.tastytrade.com/tt/shows/MT/episodes/1337

SS

I really appreciate this link @SisyphusStone .Coincidentally enough, over the last 36 hours I have watched probably 5 hours of tastytrade videos. I am doing an options cram session this upcoming week, as I think it will be beneficial for spreading as well, since similar strategies are often used in both domains. I know very little about options in general, and it's time for me to stop being lazy and learn, and their videos are very educational, and very much in the realm of practicality versus theoretical. Thanks again!

Here is another episode that is similar. Great stuff, good to watch all the way through:
https://www.tastytrade.com/tt/shows/MT/episodes/1392


Last edited by josh; September 29th, 2013 at 12:44 AM.
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  #65 (permalink)
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@josh

Thanks for posting the links, the trader anchor Bob is quite entertaining.

He showed mean reversion as the only pairs trading strategy, however most of synthetic stock pairs spreads go on widening without much mean reversion. When one stock outperforms other, there are fundamental reasons for that and to short the fundamentally strong stock and buy the weak stock in the hope of mean reversion can be disastrous.

Here is a pic of IBM vs HPQ over last 3 years and it shows how IBM has outperformed the HPQ, any mean reversion trades would only have hit the stops again and again.

Here is an article by Lex Van Dam criticizing the mean reversion pairs strategy.

Why I won?t teach pair trading to my students - MarketWatch

Mean reversion is suitable for spreads like condors, double butterfly, interexchange spreads, cash-futures spreads etc.

The butterfly on ES/NQ/YM may not be a good idea. Butterfly is more suited for a single product with different expiry months. The only synthetic spreads suitable for butterfly are treasury futures like 5-10-30 years or Scahtz-Bobl-Bund.

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  #66 (permalink)
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josh View Post
I really appreciate this link @SisyphusStone .Coincidentally enough, over the last 36 hours I have watched probably 5 hours of tastytrade videos. I am doing an options cram session this upcoming week, as I think it will be beneficial for spreading as well, since similar strategies are often used in both domains. I know very little about options in general, and it's time for me to stop being lazy and learn, and their videos are very educational, and very much in the realm of practicality versus theoretical. Thanks again!

Here is another episode that is similar. Great stuff, good to watch all the way through:
https://www.tastytrade.com/tt/shows/MT/episodes/1392

Well well, great minds think alike - or is it small minds seldom differ?!!! Glad the link was of use, Josh and thanks for yours. I too have recently finally got off my butt and begun to seriously get my head around options and like you have been intensively mining the TT archives. I don't think I've come across anything that comes close, in terms of quality and relevance, anywhere.

I made a tentative start with options some months ago with a course by Jonah Ford (spreadtrader) but he had to abandon it mid-way due to having to have surgery. Anyways, he's about to re-run it starting Oct 5th, so you might be interested since it's only $50 and I felt the first 3 weeks he did alone was value for the money. He's primarily a commodities trader and also has a course on spreads for a bit more, that I've not yet done - I was going to follow on if the options one was worth it.

I also did the $7, one month trial to John Carter's (Option Trading Strategies | Online Training | SimplerOptions.com) site. I found his approach very interesting and there were aspects to his methodology that I liked a lot. Again, I think you might learn plenty there for $7. He mainly trades weekly equity options to capitalize on the rapid theta decay. He's been on TT a few times too. He uses a squeeze system based on Bolingers, Keltners and Momentum to identify low volatility areas of congestion for trade entries. Not quite my thing as I use Wyckoff/VSA, but both methiods are essentially seeking the same result. He also swears by the fib-based VooDoo lines indicator for support and resistance. Not convinced personally, but if you're interested I can give you the ratios for a simple work-around using any fib indicator, that seems to work just as well. As a non- US resident I can't get access to the TOS platform - some BS from TDAmeritrade about UK/European regulations that prevent them from offering it. Not sure how come I can trade options through my IB platform then!!! IB's options platform is powerful and comprehensive, but, like all things IB, I don't find them very intuitive, or simple to use. The TOS platform on the other hand seems very straightforward and intuitive, though reviews are not so glowing since TDA bought it from Sosnoff - now there's a surprise!

If you're not familiar with Wyckoff I would strongly recommend taking a few hours out to at least familiarize yourself with the broad schematic (http://www.hankpruden.com/MTWyckoffSchematics.pdf) as it works very well for spreads.

Enough! Anyways, a few thoughts and suggestions there that you might find of interest - or any other subsequent reader - and good luck with the pairs/spreads trading and options.

Best

SS

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  #67 (permalink)
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josh View Post
Thanks for the encouragement and info @TheDude . Do you mean to short the ES-NQ spread as I did here and then buy the NQ-YM? If that's what you mean, it would be doing damn well right now. Russell and Nasdaq have been super strong in the last 2 weeks, relative to the S&P which has been flat to down, and the Dow has just been a dog and has been particularly weak since the 9/18 high.

I thought a fly was usually constructed such that one product was hit twice, and the other two were bought once. So for example, buy the NQ/YM and sell the YM/TF (or YM/ES even). This way you sell YM on both legs, buy NQ on the first leg, and buy TF or ES on the second leg. Is this what you were referring to, or am I way off?

Nope - you've got it. A fly is +1x, -2y, +1z so you can look at it as a spread against a spread with +1x-1y hedged/offset with +1z-1y, or you can just look at it as a fly!I dont know the ratios, but if you're doing say 2 ES against 5 NQ and 3 YM against 2 NQ then your fly will be say 2ES-7NQ-3YM

You could get really crazy and get a double fly with +1p, -3q, +3r, -1s with es, ym, nq and tf.

Generally,the more legs you add, the more tricky execution becomes to get the right price. Charting the structures also becomes quite difficult as in this example you're looking at products across 3 exchanges so getting ohlc data is impossible pretty much - unless you have a front end with an autospreader that will also construct synthetic charts from the autospreader.

Generally, the more 'complicated' the structure, the more rangebound they become, so it ends up simply working bids and offers at support/resistance points. The skill is in getting good prices through the various spreads you are trading in order to get a good price on the overall structure.

Obviously trading costs also need to be considered agaisnt the expected return per trade. Trading this way is about the only time IMO when you can add to losers becsue of the nature of the structure. If it pops out, you can put some more on pretty certain it will revert back to the glorious mean!

I dont trade in this fashion, but I know a few guys who do as a sideline to their main trading strategies. They mostly trade treasuries and energies this way, but maybe index products can be traded too?


Last edited by TheDude; September 29th, 2013 at 07:13 AM.
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  #68 (permalink)
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indiantrader View Post
@josh


The butterfly on ES/NQ/YM may not be a good idea. Butterfly is more suited for a single product with different expiry months. The only synthetic spreads suitable for butterfly are treasury futures like 5-10-30 years or Scahtz-Bobl-Bund.

This could be so.

I have no experience of index flys. I just put it out there as food for thought.

Youre right that inter product flys are more common on treasuries, but maybe it could work on index products? Unless we investigate we will never know.... The structure could well be a huge mess!!

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Too clever by half??


TheDude View Post
Nope - you've got it. A fly is +1x, -2y, +1z so you can look at it as a spread against a spread with +1x-1y hedged/offset with +1z-1y, or you can just look at it as a fly!I dont know the ratios, but if you're doing say 2 ES against 5 NQ and 3 YM against 2 NQ then your fly will be say 2ES-7NQ-3YM

You could get really crazy and get a double fly with +1p, -3q, +3r, -1s with es, ym, nq and tf.

I dont trade in this fashion, but I .............

..... think that's very prudent!!

Strewth, just reading through the setup of those B'flies made my head spin. Seems to me thzat you are introducing any number of additional risks just in terms of good executions, not only in laying on the positions, but then exiting too which might well be far more critical. Does this level of 'sophistication' really lead to a genuine edge? Personally, being a simple soul, I try and keep everything as simple as possible - the old 'KISS' principle ie. Keep it Simple Stupid.

SS

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  #70 (permalink)
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SisyphusStone View Post
..... think that's very prudent!!

Strewth, just reading through the setup of those B'flies made my head spin. Seems to me thzat you are introducing any number of additional risks just in terms of good executions, not only in laying on the positions, but then exiting too which might well be far more critical. Does this level of 'sophistication' really lead to a genuine edge? Personally, being a simple soul, I try and keep everything as simple as possible - the old 'KISS' principle ie. Keep it Simple Stupid.

SS


I agree 100%.

It does however make the illustration of what is possible with spreads and the broader possibilities of the kind of structures can be made.

You also identify the point that a traders job is in execution (not a TA analyst - thats done by TA analysts, not traders!), and spotting good points and understanding the difference bad execution will make. Autospreaders are key to this type of trading. No one will try to manually work more than 2 legs.

As Indiantrader said - these are mostly done in treasury markets where the relationships are more certain and the structures are more definite.

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