Pair Trading

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PAIR TRADING STRATEGIES

Presented by:

Industry Guide: Faculty Guide:

Anand Agrawal - 09206 Sulagn Patanaik - 09150

Mr. Vivek Gupta Prof. Devi Prasad Bedari & Dr. Jaba M. Gupta

Company:

CapitalVia Global Research Ltd.

Road Map
About CapitalVia Why Pair Trading? Project Objective Scope What is Pair Trading? Methodology Strategy Analysis Observations Findings Limitations Future Scope Pair Trading 1 November 2010

CapitalVia Global Research Ltd.
Investment advisory firm
Stock tips Commodity tips F&O

Intensive research in stock market Customers: Pan India Offices in India: Bangalore and Indore Expanding at rapid rate Pair Trading 1 November 2010

Why Pair Trading
Niche strategy Opportunity in Indian market Only FOREX

Pair Trading

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Project Objective
Analyzing different Pair Trading Strategies Finding most profitable pairs

Pair Trading

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Scope
Where
BSE NSE MCX NCDEX

What
Stock – Sector wise Commodity – Stock (Sector) Index – Stock Pair Trading 1 November 2010

Scope
Where
BSE NSE MCX NCDEX
Our Scope Software Pharma Bank-Public Bank-Private Automobile Telecom Refinery Cement Real Estate

What
Stock – Sector wise Commodity – Stock (Sector) Index – Stock Pair Trading

1 November 2010

Pair Trading
A nondirectional, relative-value investment strategy
Market Neutrality

Pair Trading
Technical analysis Statistical arbitrage

Pair Trading

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Market-Neutral Strategy

• Share Neutrality • Dollar Neutrality • Beta Neutrality Pair Trading 1 November 2010

Market-Neutral Strategy
Share Neutrality
Equal Number of long and short shares Disproportionate amount of exposure between the two legs of the trade

Dollar Neutrality
Equal amounts of long and short investments Net Dollar Exposure to Market Swing = 0

Beta Neutrality
Balancing the beta of long side of portfolio with that of short side of portfolio +β Pair Trading α +ve Market and -β α -ve Market 1 November 2010

Methodology
Select stocks Historical Data Collection
Moneycontrol.com Nseindia.com

Check for special event in a stock
Bonus issue Stock split

Find normalize/standardize value
Normalize value,

Find Pairs
Pair Trading 1 November 2010

Finding Pairs
• Correlation = • Distance trading
– Minimum mean square distance where, D =
nP = normalized price =

• Co-integration
Pair Trading 1 November 2010

Mean Square Distance
HeroHonda HeroHonda Kinetic TVS Ashok leyland Eicher TATAMot HindMotor M&M Maruti Bajaj 1 1.0796 0.2067 0.4452 0.2498 0.6901 1.5621 0.23885439 0.1161 0.0839 Kinetic 1.0796 1 0.5641 0.3056 0.5543 0.1791 0.3807 0.4781 0.7871 0.4381 TVS 0.2067 0.5641 1 0.1508 0.1366 0.2734 1.044 0.0891 0.2315 0.067 Ashok leyland 0.4452 0.3056 0.1508 1 0.1554 0.073 0.6519 0.0681 0.3153 0.1277 Eicher 0.2498 0.5543 0.1366 0.1554 1 0.2518 1.169 0.1195 0.1881 0.0724 TATAMot HindMotor 0.6901 0.1791 0.2734 0.073 0.2518 1 0.5003 0.1948 0.5154 0.1886 1.5621 0.3807 1.044 0.6519 1.169 0.5003 1 0.8738 1.2734 0.7127 M&M 0.2388 0.4781 0.0891 0.0681 0.1195 0.1948 0.8738 1 0.1497 0.085 Maruti 0.1161 0.7871 0.2315 0.3154 0.1881 0.5154 1.2734 0.1497 1 0.1338 Bajaj 0.08389 0.4381 0.067 0.1277 0.0725 0.1886 0.7127 0.085 0.1338 1

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Co-integration

“If two or more series are themselves non-stationary, but a linear combination of them is stationary, then the series are said to be co-integrated”

Pair Trading

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Co-integration
Drunk And Her Dog Girl wonders around a random path Xt -Xt-1 = Ut x Dog responds to the sound of her voice and adjusts its meandering according to how distant she sounds: Yt -Yt-1 = -α(Yt-1 - Xt-1) + Vt t−x

Pair Trading

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GRETL: Importing Data

Pair Trading

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GRETL: Model Selection

Pair Trading

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GRETL: Testing Pairs

Pair Trading

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GRETL: Test Results - 1

Pair...
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