How do most prop shops (like a WTS) handle buying power with regards to pair trades or hedged positions. If I am long $20K and short $20K, is my buying power typically hit for the full $40K (exposure)?
Perhaps, but they would likely offset the arbitrary $40k with additional gearing. There would ideally be some beta and vola adjustment, but that's going to be up to the discretion of the firm. You may want to ask them.
you are hit with a full 40k, however shops such as WTS will give you more buying power if your strategy is market neutral
as of now, it is full 40k in your example. because for them to reduce your risk exposure they need a system to evaluate the risk embedded in your portfolio, which is really complicated.
In our case, we allow up to 30 x your equity as long as you're relatively hedged ( $500K long, $490K short for example). You are allowed 6 times your equity with no "haircut" fees. 2% per Year for balances between 6 and 10 times equity, thus less than 1% per Year for carrying 10 times overnight. No haircut fees for intraday balances. IMO, to be successful as a pairs trader, you must have the ability to carry positions for days or weeks.... the "pure" daytrader is adapting to this need lately as well. FWIW guys!! Don
As long as the symbols are the opposite direction. You can't be long a short (bear) ETF vs. long JCP for example. But your example is fine. We used to break down the actual pairs, but too many to follow, so we just go by the $$dollars long and short. Hope this helps, Don
No reason to worry, our traders have software that helps them with "correlated" pairs, and usually have multiple pairs, thus the risk curve is flattened out pretty well. Many simply use an ETF to hedge their naked positions, but most do their homework for the 2 stock correlation. All the best, Don