Queries
Even before I get into the “How do we implement this strategy” part, I thought it will be a good idea to pen down my questions at this point. I know some of them might have obvious answers and some would just become redundant, but here goes:
1. Prices constrained by Contracts: The way I understand futures, there are set futures for a given stock at set prices, typically expiring end of the month. So, there is a huge constraint introduced by the availability of a future at a given price, unlike the underlying. This, I believe, I will figure out as I start trading in future contracts.
2. Margin: The only way you can make any decent returns on Pair Trading, as I understand it now, is by trading in derivatives. In fact, in NSE, thats the only way you can do pair trading. How else do you carry forward a short position?
3. “Gaps”: This is a big one. The query I have is, if end of a particular day you decide to get out of a trade, whats the guarantee that you will be able to exit at that price when the market opens the next day? as in, what if the market opens with a gap? what exactly is the limit mechanism to sell futures?
4. A long position can be taken as an option, or as a future. What will be the difference in terms of returns? Is there a standard relationship between these returns?
5.How big a concern is liquidity? I mean, the subset of stocks where you can spot pairs will become few in number, thereby making pairspotting an easy non-computationally-intensive task.
6. How do you implement a pair trade where one of the elements is an index (i know this one) or a sector index or a group of stocks? How do you exit?
7. How long can you practically keep a position, assuming neither the profit booking target nor the stop loss target is hit? I mean, will the right contracts be available to carry forward a position?
8. What will be impact of brokerage in percentage terms, on the overall returns, particularly if you need to carry forward a position?
9. Does it make sense to go with a time frame for mean reversion in mind, as another way of stop loss? If yes, what could be a possible time frame?
10. What is the philosophy behind pair trading? As in, why shd mean reversion happen? I guess this is the most important question in my mind, and I hope to find some answers to this as we go along.
1 year ago