This segment examines and discusses pairs trading with explanations how it works, why one should consider it and how it applies in general to managing your trading portfolio. There are lessons here for all traders, whether you trade pairs or not.
The concept of pairs trading was explained first. Tom used an interesting analogy from the world of Hollywood to help explain the concept. Positive correlation pairs trades were explained as well as negative correlation trades.
A table was displayed of both positively and negatively correlated pairs. A 1 month, 3 month and 6 month positive correlation between the /ES (S&P 500) and the /YM (Dow Industrials) was. A 1 month, 3 month and 6 month negative correlation using the /ES and the /VX (VIX) were shown.
Why a trader would we place a pairs trade was next discussed. Several solid reasons were listed. A second set of tables was displayed showing the SPY (S&P 500 ETF) and the DIA (Dow Jones ETF). The table displayed the upside range, downside range, mean range and standard deviation range in both the SPY and DIA and a SPY/DIA spread. How a pairs trade reduces risk was explained.
There are risks in pairs trading. The main risks were explained. That was followed by an explanation when a trader would enter a pairs trade. It was followed with an example which included a chart of the pair.
Where we look for potential pair trades was next discussed. Several areas were listed and another table was displayed illustrating one area, specifically, the /ES and the /ZN (Ten Year Note) for a ratio pairs trade. The table included the symbol, value per tick, current price, notional value, implied volatility and IV adjusted ratio.
Finally, managing pairs trades was explored. Why legging in and legging out does not make sense was explained along with what type of profits one should target.
Watch this segment of Best Practices with Tom Sosnoff and Tony Battista for the details about the benefits and risks of pairs trading and how it applies to your trading in general.
This video and its content are provided solely by tastylive, Inc. (“tastylive”) and are for informational and educational purposes only. tastylive was previously known as tastytrade, Inc. (“tastytrade”). This video and its content were created prior to the legal name change of tastylive. As a result, this video may reference tastytrade, its prior legal name.