2 and 3-stock Replication Baskets (Free Trial Information Below)
These reports are our flagship product and what distinguishes us from the competition. Pairs Trading has been around since the late ’80s when quant traders discovered they could use their computer to find pairs of stocks whose performance was highly correlated to one another. When one stock of the pair traded up and its pair either traded down, or remained unchanged, a trade opportunity presented itself. The traders would put on offsetting trades in the two securities–selling short the one that had traded higher and buying the laggard, or vice-versa. When the relationship between the two stocks righted itself, the trade was unwound and a tidy profit was pocketed. Since there was a simultaneous buy and sell of stocks, these trades had no underlying exposure, or delta, to the stock market as a whole. Over the years, the pairs trading space has gotten very crowded and the once tidy profits have been squeezed ever thinner.
Additionally, the time period two pairs remained mis-priced to each other got shorter and shorter. Speed of access to the market was trumping computational speed, and modeling ability. With the advent of ever cheaper computers, and parallel processing supercomputers, we are now able to increase the complexity of the pairs trade. Instead of trading stock A versus its highly correlated pair, Stock B, we now look to trade stock A versus a basket of stocks whose combined performance correlates more highly with stock A, than any one individual stock does. Now, writing that sentence is a lot easier than executing the strategy. If we limit ourselves to trading only the stocks that make up the S&P 500, there are only 499 possible pairs to each proverbial stock A. However, when we look for 2 stock baskets, there are now 124,251 possible baskets, or combinations. In combinatorics terms, 499 choose 2 = 124,251.
The numbers really explode as you increase the basket size. For three stock baskets, there are 20,584,249 possible candidates to be the best match. And that’s just for one stock. We must search 20,584,249 possible baskets for each of the 500 stocks in the S&P 500. This daunting number is over 10 billion possible pairs trades we search to come up with the best trades to execute.
Our ability to quickly and efficiently evaluate these possible combinations is our competitive advantage and the unique product we offer our customers. Now, why increase basket size if it gets computationally very expensive and time consuming to do so? The larger the number of stocks in the basket, the higher the correlation that basket has to Stock A. Also, as basket size increases, individual name risk decreases. The positive effects on your risk profile by decreasing name risk cannot be overlooked.
Our daily updated reports, based off market closing prices, are offered free of charge. Often times, however, opportunities that present themselves at the close, are no longer available when the market re-opens the next day. These latency problems can be overcome by subscribing to our live-price reports which are updated continuously throughout the trading day. Not only are latency issues mitigated via the live reports, but subscribers are also presented considerably more trading opportunities as the reports are run at many time slices. These reports effectively constitute a “hedge fund in a box.”
New: Our trade recommendations are now also accessible via our RESTful API. Download them straight into Excel, or your own trade execution system. More info, here.
Send us your contact information to get your Free Trial started!
Email: info@empirasign.com.
Phone: +1 646-837-8848