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sheepsucker
Registered: Jun 2009
Posts: 213 |
08-29-12 06:52 AM
Hi,
One of my pair-trading strategies has proven quite successful and I would like to increase leverage.
Can I just start trading options on the stocks I get signals for in order to increase the leverage? There probably are some things I need to take into account.
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H2O
Registered: Jan 2002
Posts: 988 |
08-29-12 11:23 AM
Pair trading using options requires a good understanding of how options move relative to the underlying and what causes options to move in general (delta, rho, vega). I suggest you educate yourself on this first and also use that time to paper trade so you get some understanding of option execution specifics (liquidity / bid-offer spreads etc.) although nothing can compare to live trading.
I'm not saying it cannot be done - there is certainly room for options in a pair trading environment, but it is not as straight forward as you suggest in your initial post.
Alternatively you could consider joining a firm which will provide you with extra capital so you can trade more size in the underlying. (I have no affiliation, but Bright - through Pairco - should be able to help you - just like many other firms btw.)
Hope this helps
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sle
Registered: Apr 2003
Posts: 1609 |
08-29-12 09:51 PM
You want to do it in short-dated options - this would avoid Vega risk. The beauty of trading pairs using options is mostly in the fact that you can take into account the directionality of the move. For example, if you think that in a rally stock A will outperform stock B, you can buy calls on A and finance by selling calls on B. This sort of thinking, combined with simple break-even calculations and some basic thoughts on convexity in the pair would get you far enough.
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FrankSlaughtery
Registered: Aug 2010
Posts: 811 |
08-31-12 01:56 PM
Quote from sle:
For example, if you think that in a rally stock A will outperform stock B, you can buy calls on A and finance by selling calls on B.
you are taking a HUGE risk doing that as you are naked on B - what happens if B is bought out at a 50% premium?
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H2O
Registered: Jan 2002
Posts: 988 |
08-31-12 03:00 PM
Quote from FrankSlaughtery:
you are taking a HUGE risk doing that as you are naked on B - what happens if B is bought out at a 50% premium?
That is always a risk, but the same applies if you're trading the underlying... (and there's also the same chance that A is bought out, in which case you would benefit)
OP was asking about pairs trading with options, I assume an understanding of the risks of pairs trading.. Sle just showed 1 way to use options from a pairs trader's point of view.
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