Www.pairstrading.co.za. Derek Crookes: ◦ Basic introduction to pairs Trading Jonathan Roche: ◦ Highlights of a Pairs Trading Case Study ◦ Searching

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Pairs Trading23rd October 2013


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

Presentation


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

Risk Warning


‘Pairs Trading’ is an investment strategy used by many Hedge Funds.

Pairs trading or statistical arbitrage was first developed and put into practice by Nunzio Tartaglia, 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.

History


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

Pair trade strategies & terminology


Books Trading Pairs – Mark Whistler Statistical Arbitrage – Andrew Pole Pairs Trading – Ganapathy Vidyamurthy

3rd Party Price feed into excel Don’t rely on statistics, or patterns etc, only


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.

What is a pairs trade


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

What is a pairs trade continued


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

How to determine a pair


Long Ned vs Short Std 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

Calculate a Pair position


Margin – 10% (R10 000) ROWC – 50% rounded

Calculate a Pair profitability

Stock Ned SbkNotional 100 000 100 000Price 195 124Shares 513 806

Act Notional 100 035.00 99 944.00 Comm Charge 0.20% 0.20%Entry Cost 200.07 199.89

Exit Price 211 127Shares 513 806Notional 108 243.00 102 362.00 Exit Cost 216.49 204.72

Total Cost 416.56 404.61 821.17 Gross profit 8 208.00 2 418.00 5 790.00 Net Profit excl Int 4 968.83


Performance graph – IMP vs AMS (500 Trading days)


Relative graph – IMP vs AMS

+-25



+-20



+-12



+-10


Performance graph – INL vs INP (500 Trading days)


Relative graph – INL vs INP


Pair Performance– INL vs INP


Relative graph – INL vs INP


Pair Performance– INL vs INP


Performance graph – NED vs FSR (500 Trading days)


Relative graph – NED vs FSR


Relative graph with Std Dev NED vs FSR


Pair Performance– NED vs FSR


Pairs Ratios / Relative1 MTNVOD 238.75%2 SHPCLS 237.58%3 ANGGFI 226.67%4 RMHFSR 187.29%5 RMHNED 172.61%6 IMPAMS 142.57%7 WHLSHP 33.39%8 SOLBIL 31.93%9 BGASBK 23.72%10 BGANED 19.53%11 BILARI 18.77%12 SBKNED 8.95%13 ARIAGL 8.19%14 SPPSHP -6.98%15 INLINP -35.91%16 BVTMTN -45.88%17 TRUTFG -56.55%18 LBHOML -61.80%19 GFIHAR -63.20%20 WHLMPC -77.96%21 SBKFSR -80.27%22 BGARMH -87.74%23 SBKRMH -117.53%24 TRUPIK -124.04%25 SHPMPC -131.04%26 NEDFSR -131.16%27 MTNTKG -145.84%28 VODTKG -184.46%29 KIOEXX -212.93%30 EXXBIL -231.33%31 SPPPIK -239.36%32 KIOBIL -248.53%


MarkerABL BGA BVT DSY FSR INL INP MMI NED OML REM RMH SBK SLM TBS MTN VOD TKG CLS MPC MSM PIK SHP SPP TFG TRU WHL AGL AMS ARI BIL EXX IMP KIO SOL LON NHM ANG GFI HAR

12:09:00 -2.87% -1.40% -0.78% -0.02% -0.34% -0.04% 0.23% -0.60% 0.12% -0.09% 0.08% -1.32% -0.53% -1.84% 0.06% -0.81% 0.79% -1.19% 0.89% 0.60% -1.39% 5.64% 0.22% 1.80% -1.93% -0.67% -1.43% -1.49% -0.75% 0.15% -1.24% -1.21% -2.52% -3.08% -0.81% -1.05% -2.12% -0.64% -0.47% -0.12%1725 15266 26144 8398 3533 6886 6857 2469 21025 3183 20166 4843 12500 5399 29549 20208 11490 2816 5650 15300 15778 4810 18015 13091 11375 9620 7590 24105 42790 19389 30413 15525 12331 41097 50073 5195 4160 15780 4610 3450

11:00:53 -1.75% -1.56% -0.69% -0.24% -0.65% -0.23% 0.18% -0.56% -0.03% 0.09% -0.71% -1.79% -0.95% -2.18% 0.24% -0.73% 0.23% -1.16% 0.36% -0.53% -0.51% 5.64% -0.70% -0.09% -2.45% -1.34% -1.36% -0.60% -0.95% 0.05% -0.87% -1.36% -2.71% -2.84% -0.76% -1.05% -0.35% -0.58% -0.15% -0.29%

-1.13% 0.16% -0.09% 0.21% 0.31% 0.19% 0.06% -0.04% 0.15% -0.19% 0.79% 0.47% 0.41% 0.35% -0.17% -0.08% 0.56% -0.04% 0.54% 1.13% -0.88% 0.00% 0.92% 1.89% 0.52% 0.67% -0.06% -0.89% 0.20% 0.10% -0.36% 0.15% 0.19% -0.24% -0.05% 0.00% -1.76% -0.06% -0.32% 0.17%

-2.87%

-1.40%

-0.78%

-0.02%-0.34%

-0.04%

0.23%

-0.60%

0.12%

-0.09%

0.08%

-1.32%

-0.53%

-1.84%

0.06%

-0.81%

0.79%

-1.19%

0.89%0.60%

-1.39%

5.64%

0.22%

1.80%

-1.93%

-0.67%

-1.43% -1.49%

-0.75%

0.15%

-1.24% -1.21%

-2.52%

-3.08%

-0.81%-1.05%

-2.12%

-0.64%-0.47%

-0.12%

-4.00%

-3.00%

-2.00%

-1.00%

0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

7.00%

ABL BGA BVT DSY FSR INL INP MMI NED OML REM RMH SBK SLM TBS MTN VOD TKG CLS MPC MSM PIK SHP SPP TFG TRU WHL AGL AMS ARI BIL EXX IMP KIO SOL LON NHM ANG GFI HAR

-1.13%

0.16%

-0.09%

0.21%0.31%

0.19%0.06%

-0.04%

0.15%

-0.19%

0.79%

0.47% 0.41% 0.35%

-0.17%-0.08%

0.56%

-0.04%

0.54%

1.13%

-0.88%

0.00%

0.92%

1.89%

0.52%0.67%

-0.06%

-0.89%

0.20%0.10%

-0.36%

0.15% 0.19%

-0.24%

-0.05%

0.00%

-1.76%

-0.06%

-0.32%

0.17%

-2.00%

-1.50%

-1.00%

-0.50%

0.00%

0.50%

1.00%

1.50%

2.00%

2.50%

ABL BGA BVT DSY FSR INL INP MMI NED OML REM RMH SBK SLM TBS MTN VOD TKG CLS MPC MSM PIK SHP SPP TFG TRU WHL AGL AMS ARI BIL EXX IMP KIO SOL LON NHM ANG GFI HAR


Trading for 10 years

4 Children and Wife

Bsc Mech Eng MBA U of CT

This is all he does!

Jonathan Roche

Documents

Www.pairstrading.co.za. Derek Crookes: ◦ Basic introduction to pairs Trading Jonathan Roche: ◦ Highlights of a Pairs Trading Case Study ◦ Searching