Pairs Trading

Discussion in 'Trading' started by datahogg, Jul 27, 2009.

  1. datahogg


    Being new to pairs trading I hope experienced traders can add to my knowledge. Normally for a pair say
    stock ABC and XYZ where the correlation is say greater than 80%, and we go long ABC and short XYZ, we buy a dollar amount of ABC and short an equal dollar amount of XYZ.

    But what if options are used. The disadvantages for options would seem to be time decay (THETA) and implied volatility (VEGA). Vega could go either way but Theta would be a disadvantage. In buying the calls for long ABC, and puts for
    XYZ would you multiply the delta of the
    combined calls and the price of ABC to
    get a dollar amount and then adjust the
    puts product of delta and price to obtain equal dollar amounts for the calls and puts combination?

    After some period of time would the
    dollar amounts of the long and short sides change. And if they change, should the pair be adjusted to bring the pair back to equal dollar amounts?

    Thanks in advance. H. Hampton