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The X-Pairs

Note: these strategies for viewing information only, they are not for sale, nor to solicit or suggest trading activity.


leveraging pair correlations for higher risk and higher reward

higher risk is sometimes worth it

7 February 2024

Our Pair-trading methodology offers unparalleled risk-adjusted returns because (unlike the traditional approaches to arbitrage) its relative valuation assessment is not static; it dynamically changes with time as asset relationships can shift over time. Pair-trading offers a unique comfort in reducing tail-risk. On the other hand short-selling is not always practical. Sometimes the shares are not available to borrow, and outside of a small set of symbols, the borrowing fees can be formidable. This limits the short leg to very liquid symbols such as SPY where inefficiencies in a pair’s relative valuations are not as good as, say, two stocks in the same industry. What better relative valuation can exist than the one between a symbol and its net-asset-value NAV (assuming it is published frequently enough). The NAV cannot be sold-short but perhaps the strength of correlation will compensate for the added risk of taking only one side. It turns out, it can work. Here is an example using GOF vs its daily published NAV ( Blue dashed lines imply profitable units and red represent net-loss):

The price scale for the NAV is on the left, and the asset on the right vertical axis. Each blue arrow shows a unit of accumulation and the white arrows show exit signals for all layers accumulated until then. With unit size of 100 shares here is the result over the last two years on the daily scale with a profit factor of 5.6.

The equity curve on the far right is for the same symbol over the last 15 years on a weekly chart (itself not shown) with a profit factor of 5.3.

The set of symbols which publish their NAV daily is limited to CEFs and they tend to be thinly traded.

The same signals can be applied to short selling with similarly good results. However, if we are resigned to long-only positions, then a huge range of possibilities open up. Indeed the short side on the primary symbol can be taken independently as well. Here is an example of Gold (GLD) vs (inverse) Dollar index (UDN):

The Equity curve including commission and slippage is shown to the right. The unit is 15 shares and profit factor is 29.9 over two years.

The far right shows GLD/UDN weekly the performance of SHORT-only positions over ten years, with unit size of 7 shares, and a profit factor of 8.6!

The price chart for the latter is below. Blue arrows indicate long entries, and red imply short. Blue dashed lines imply profitable units and red represent net-loss.