ADVISORY: The following relates only to using an options pair for trading in lieu of a stock pair, or as an addition to a stock pair. Don't waste your time with it if you have no interest in the subject. Perhaps it is a better subject for another location to post, but for here, it is a reply in courtesy to cdcaveman. You just asked the $ 64,000 question. http://www.imdb.com/title/tt0047701/ When I started doing trades like this (unfortunately ROI potentials almost never came up THIS good), I looked into doing options for routine use as a proxy to stocks. (I know the very basics of options, that's all.) I was very disappointed because of the numerous reasons that appeared to me would not let options work. (Even someone with a rudimentary understanding like me could see this.). So I sadly dropped the interest using options. I found THIS current trade because the pair was on an old watch list I had of former pairs I had traded. Approaching Aug 1, it appeared to be such a high probability trade for BIG success, it energized me to try again looking at options. Especially so because many of my other trades are with stocks trading medium low to very low volume, but this pair trades with more than that; I expected to find a richer field of options choice. I found, yes, better choices than I would find in my other trades, but still very inefficient choices. Again I was disappointed. To put the final kabosh on my interests in using options, I checked out a forum (or is it a thread ?....I don't know the difference), on using options with pairs on ET. It was only a handful of pages and all Greek to me (pun intended). My only take-away was in spite of these posters obviously knowing what they were talking about, (1) they were befuddling each other, and (2) inconclusive between themselves for any consensus. So if the rocket scientists can't find an efficacious way of using options, what am I trying to accomplish? With a pair as good as HOT HST's Aug 1 opportunity, I would be ok using even an inefficient pair of options. I think I saw that possibility with this pair's field of options. But even so, I did not enter for the following reason (as flawed as it may be): It seems reasonable the narrowest bid-ask spread is at/near the stocks' current trading price. Typically, I would only find at best a 10 cent spread, at the narrowest. So if I opened an option position on each leg with the options' bid-ask spread working against me (I hit the best bid or lifted the best offer), that inefficiency may be tolerable. My BIG concern is that over time--many weeks perhaps, as may be the case with my swing trading--the trading prices of the stocks move quite away from where they were when I entered the options trade, causing the bid - ask spread in the options to become intolerable as the time comes to close the options. And that is when the trade moves IN my favor ! Should the trade move away from me, I'm looking in the face of causing injury on top of injury. No thanks. Perhaps, I am looking at the wrong thing in options. Maybe I should be matching options by manner of their greeks, if that is even possible, regardless of what appears to be a mismatch between a call's and a put's respective strike and expiration date. But what appears to be a match at the open may be a huge mismatch over time in a position with them, as the greeks in the call drift largely away from the greeks in the put AS the stock pair moves, and may move dramatically. Intuitively--which is all I have in lieu of knowledge--these dynamics would make what appeared to be sensible in the open become senseless while in the trade. Totally bewildering to me. Or am I over thinking this ? (Thinking is a generous word to use, as I don't have the knowledge of options to put my arms around this. And if I did, I don't relish getting into a conversation with another of like knowledge as the one I described earlier.)
Yes most over think options trades... and I'm so interested in statistical correlation trading I will do the research necessary to get the leverage needed out of options without the slippage while considering all the related risks ... I'm typing on my phone now... I'll look more into it and get back...
ok ok ok .. i've been thinking and reading about this... of course this pair trading is the basis for swaptions . vol swaps etc...... my thoughts are this.. you have two correlated pairs.. to what statistical significance..is a good question.. short synthetic on one long synthetic on the other.. meaning if one has run up and the other has lagged. you can say sell a call buy a put to get short synthetic. buy a call and sell a put to get long synthetic.. this actually is a butterfly looking trade... meaning the profit graph i imagine would look that of a butterflys.. you could do it with risk reversals... one short synthetic risk reversal one long risk reversal... putting your short strikes at what you predict to be the convergence point.. of course these are all for convergence trades... tail events i wanna revisit later with these trades.. cause convergence trades are short the large decoupling of the pairs.. for divergence trades..... different strategies are better considering the volatility of the pairs together and them seperately.. which gets into the higher order greeks.. but no need to get to that level of complexity till you actually have some ideas of how to trade these with options.. how to be long divergence.. decoupling... i want a limited risk way of taking advantage of say a home depot running a Lowes out of business.. i'm thinking of volatility assumptions as we speak.. vol up on lowes taking a shit and vol down on lowes going up.. so thats another consideration.. how do we get that tide working in our favor to.. meaning its ok to be short a little vol in the home depot taking over the market.. and wanna be super long vol with the lowes.. thinking thinking.... could just be a premium buy... long puts on shitty , long calls on winner.. i'm not sure how butterflys or ratio backspreads could be used in these strateges.. other then.. use the ratio backspreads as protection for tail events on the convergence trading.. meaning buy some way otm ratio backspreads to cover your short options... cause you surely don't wanna blow out if it completely de couples.. i don't know these are just my initial thoughts..
I dunno either caveman. But you are on a roll with your thinkin'. I may be wrong, but I think the last post on that options pair trading on ET was three months ago. I was going to suggest you do your posting there on the subject. Should any of the old players there or perhaps a new drive-by sees your post/s, you could get a dialogue moving. I highly encourage you to do it. I am glad you're serious. To me it is an important subject. Of course the acid test of what you come up with is Live Fire and in Harms Way trying out whatever you come up with. But nothing wrong with paper trading either. Let me know; I will track it. PM me when you think you are closing in on something workable. But we should drop the subject here because it is not germane to this thread CHARTS of NOTE.
caveman........ try this thread: http://www.elitetrader.com/vb/showthread.php?s=&threadid=203158&highlight=options+pair+trading No one has posted on it for a very long time, but you may wish to review it and PM or email those posters to come back and continue the dialogue. Or start your own thread on the same subject.
Dow Transports now trading in a textbook wedge pattern: The action in the transports more closely reflects the global economic picture, and at least on the retail side, a slowdown in transportation meshes with retailers and wholesalers reporting high inventory levels and slow turnover. More specifically, North American trucking stocks have been looking vulnerable as lower volumes lead to compressed profit margins. J.B. Hunt Transport Services (JBHT) is one component that looks attractive from the short side, after a failed breakout early this summer, and a disappointing earnings announcement last month. J.B. Hunt currently trades with a growth-stock multiple as expectations for a slow but steady economic recovery in the US have boosted confidence. But now that sentiment is shifting, JBHT could drop significantly and still carry a reasonable valuation based optimistic forward estimates. Full commentary here...
Small Caps will be a key indicator this week... Small cap proxy the Russell 2000 index (chart showing the iShares Russell 2000 Index Trust) has failed to confirm the series of new highs in blue-chip indices. No rally for the Russell indicates less risk appetite along with lower growth prospects.
Brunswick Corp (BC) looks vulnerable sitting right below resistance area. A breakout to suck the bulls in, and then failure would be the best case scenario for bearish traders. Harley Davidson (HOG) is a good example of what investors think of leisure products these days. Of course HOG has a higher valuation than BC - so was a bit more vulnerable - but both should see lower trends as consumers pull back.