what is the best way to construct a pairs trade: long IWM ($209) short SPY ($584) ratio is 1:2.8, or short 5 SPY for long 14 IWM So 500 SPY =$292,000 long, and 1400 IWM = $292,600 short. QUESTION 1: Does the broker allow me to use the short cash to not pay margin interest? or synthetically with options, not sure how much the spreads and slippage are, but for example: long 5 MAR21 SPY 585P @-$10.50 short 5 MAR21 SPY 585C @+$10.80 long 14 MAR21 IWM 209C @ ~-5.25 short 14 MAR21 IWM 209P @ ~+5.05 QUESTION 2: is this better executed with options like above, and are NTM strikes the best way? Any other comments or advice, as I have not done a trade like this before.
A typically traded ratio is 1 lot ES against 2 lot RTY. The difference of contracts can be charted using the contract multipliers. Using index numbers, its ((50*5,804.24) - (100*2,063.03)) ~ $83,909 Both contracts have a 50 times multiplier, so you have to equate that notional exposure to share counts for the ETFs if you want to approximate this hedge ratio.
Good Evening elite1974, Yes, the broker will allow it. Use all the leverage you can. Just know what you are doing. It is very hard to get rich without leverage. I now trade options as well as ES futures. ES futures , I am the Master trader, but options a bit tricky. I am trying my best to get rich with SPY and QQQ options, so far no good luck.
Traded for many reasons. For starters the vol of an index spread is non trivial to model and trade. That can mean the options market has less of an effect, or just a modified effect on the price action. Some traders would say you have better odds speculating on the relative performance of contracts, than either contract outright. Also, you could make the argument that you have more information about a pair of indexes than just one. Hedging the differential involves the estimation of multiple betas, and since this is a long/short position (index spread), it's a little messy. The differential of contracts is mark-to-market with daily settlement, and CME gives ~70% margin reduction on the risk. That means you can lever it up like 3X as much as an outright future for roughly the same margin. This is also used to cut margin on overnight futures exposure. Having spread risk means you compete with a different set of market participants. FX and rates are futures spread markets, so futures traders are used to trading inter market spreads.
All good points thank you for taking the time to give that explanation. I like the idea of margin advantages. Does that come with a trade off lower profitability per range of movement? So like the raw index may soar and you wind up making half as much or less on the spread? My thoughts are that reduced risk also means reduced profits. The market is highly efficient and since the exchanges like to promote these spreads and buying options, I just can't help but be skeptical. I last tried spreads 30 years ago and come to the conclusion what's the use. But for the record I have never ever bought an option, I have only sold them naked. I find there is money in taking risk, and no risk no money. How do you determine how to manage a spread trade? Is is a waiting game, a vol play or just a investment. At what point has it gone wrong and you must unwind it? These are all things that I have struggled with spreads.
This depends on the context. The tradeoffs are gross leverage up, net exposure down, sensitivity to liquidity up, and larger tradable universe. With so many contracts to choose from, and since the exchanges have agreements (inter exchange margin discounts), you could argue there's more opportunity. Like I said before, moves in ES are dominated by the mag7 vol trade, which can help or hinder a trader. Having a heavy and liquid vol market can reduce or increase profitability, depending on the trader, the strategy, their level of experience, access, tech and skills. The exchange policy allows the FCMs to use less capital to open and maintain positions. If an FCM can post less margin because their aggregated positions are being netted out, then they can get a higher return on working capital. So this is working for the FCMs and the exchange. In my opinion, the spreads appeal to a certain kind of trader, and require a pro type skill set to really fuck with. If you're just considering returns, then the spread won't outperform the outrights over the long term. Some spreads may outperform it over shorter time frames. At 1/3 the risk, and with two books to manage, it's not outperforming the naz or S&P, but that's not why traders are messing with it. To me, the spreads are just as important for indication as they are for trading opportunities. There is a multifaceted appeal; leverage and modified vol risk are the big ones. The spread risks map to regular trades occurring in the market; large caps outperforming small caps, or big tech outperforming the S&P. Here is a list using micros Buy MES / Sell MYM ~ Synthetic Nasdaq 100 (in a 1:1 ratio) Buy MNQ / Sell MES ~ Synthetic Tech Index (1:1) Buy MES / Sell MNQ ~ Synthetic S&P 500 (2:1) Buy MNQ / Sell MYM ~ Growth/Value Spread (2:3) Buy MYM / Sell M2K ~ Market Cap Spread (2:3) Buy MES / Sell M225 ~ S&P / Nikkei index spread (1:1) You have to be familiar with the cash value and the cash value of a typical move over a day/week/quarter. My answer is that it can be all those things. It can be a waiting game where you wait for the NY open and buy NQ against a YM short. It can be a daytrade where a high or low prints and you fade it. It can be an investment if you carefully manage the risk, and act patiently (weekly VWAPs can even come into play, lol). Some of them, like the ES/NQ and NQ/ES can become vol trades. The ES/YM spread can be used to do anything you can do with the Naz outright (but less risk/liquidity).