Dumb Math Question

Ok, in a pairs trade, lets say ABC is trading at 100 and XYZ is a 90. Is the spread 10% (10/100) or 11% (10/90)?

 

not a dumb question. Normally I do it against the relevant benchmark. If it was a risk arbitrage deal I would say the spread is 11percent because that’s what I can earn. If it was a stock compared to the spx, I would say the stock is trading 10percent under the index.

 

Thanks. I think to describe a pairs trade, I'll stick to the number of points rather than a percentage and show them a chart.

 

You can do that too. there’s no wrong answer

 

I recommend building using beta spread instead of a price spread.

1. Beta of Co A / Beta of Co B = spread
2. $ value of trade in A * spread = $ value of trade in B
3. $ value of trade in B / share price = units

 

What's is beta spread? Is beta excess returns in this example?

 

No it's typically 1yr Daily adjusted beta.

 

Lost me on this. If you have a sec, want to run an example? Thanks

 

ABC is 11.11% overpriced relative to the other security XYZ is 10% under-priced relative to the other security, of course comparing 2 stocks and saying that AMZN is overpriced relative to AAPl just because of a higher stock price is ridiculous you would have to measuring a ratio like P/E to make that judgement or a relative performance scale.