Pair Trading Mean Divergence (breakout?)

Discussion in 'Trading' started by Kedwards, Oct 17, 2009.

  1. Hello,

    from what I have read most pair trading is betting on reversion to mean with a longshort position. I'd like to ask, can you bet on divergence from the mean without having a directional bias? In other words, you don't know which instrument will outperform/underperform.

    In options this would be something similar to a long straddle or short butterfly, but how would you construct that on a spread of two instruments, using equities or futures?

    I'll give an example. BAC had earnings on Friday. Last week (October 6-9th) it had similar percentage performance to XLF, a financial ETF.

    By Monday, this 'spread' started to diverge from the mean, with BAC outperforming XLF most of the week. Until they disappointed on earnings.

    Last week, with no bias on whether BAC would outperform or underperform XLF, is there a spread I could construct to bet on that? Some type of two instrument synthetic short butterfly?

    It would be greatly appreciated if some spread traders could advise.
  2. this picture shows BAC/XLF with similar performance last week, and then you see the spread start to widen on the 12th. I'd like to know if there is a spread I can create that benefits from that spread widening, without a directional bias on whether BAC will outperform or underperform.