Market Measures

Monday – Friday | 9:00 – 9:20a CT

Opportunity in Pairs Trading

Market Measures

Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before deciding to invest in options.

A pairs trade is conducted when we think one asset is relatively overbought/oversold relative to another correlated asset. The key metric we look for when determining whether or not a pairs trade is feasible is correlation.

For a pairs trade to make sense, we look for a correlation between the assets of above 0.6. Below 0.6, there is no reason to think the assets will diverge/converge since their price relationship is weak.

So how often do we see correlations between major pairs trades within of 0.6?

  • NASDAQ and Russell, Gold and Silver, Euro and Pound, Aussie and Canada, Corn and Soybeans.
  • Observed rolling 3-month correlations for the past 10 years.
  • Computed the % of time that each pair had a correlation between 0.6 and 0.8 (feasible pairs trading range)

We find that the pairs’ correlations stay within 0.6 to 0.8 less than 50% of the time, meaning that should take advantage of these pairs trades when a divergence in price presents itself since the correlations do not stay in line all the time.

Market Measures More installments

See All »

Latest tastytrade Videos As of September 23

Most Shared From the last 30 days