The Powerful Edge of Market Neutral Equity Pairs Presented by: Don Bright.

The Powerful Edge of Market Neutral Equity Pairs

www.PairTrader.com

Presented by: Don Bright

What is a Pair?

The combination of two stocks to profit from their relative change in price through divergence or convergence of the spread price.

Statistical Arbitrage vs. Risk Arbitrage

Created for different purposes traded with many different strategies

Creating a Spread Price to Watch

Example: Long Alcan vs. Short Alcoa

DifferentialLast Price of AL minus Last Price of AA

48.06 – 30.58 = 17.48

• Factor– (.65 x AL) – AA (.65 x 48.06) – 30.58 = .66

• RatioNumerator and Denominator

AA divided by AL 30.58 / 48.06 = .64

Trading Considerations

Goal is Market Neutral

Choices are: Dollar Neutral ($1 long to $1 short)

Beta Neutral (H.V is substitute)

Share Neutral

Best Pairs Created From:

Same Industry Group

Correlated

Exhibit Mean Reverting Tendencies

Why is there the probability of mean reversion over time?

Fundamental Difference Between Stocks

Comparing Metrics is Straightforward

Overvalued / Undervalued to Peers

CnpSrp100 65-Day Chart

Metrics used in Fundamental Comparisons

Value out performs growth when risk adjustedCompare:

Market CapPrice to Book (P/B)Tangible Book ValuesPrice to Earnings (P/E use TTM)Dividend YieldIndustry Group

Short the overvalued stockBuy the undervalued stock

Spread History

Compoundable TradesPredictabilityIntra-day ScalpsMarket Neutral Swing TradeRelative Strength PairsBasketsPair InvestingFundamental EdgeTechnical Edge

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