Pairs trading is used to take advantage of the change in relationship between two underlyings. This is done by being long one underlying and being short the other. In this segment we look at pairs trading between DIA and SPY with options.The study:
- 45 DTE
- Simulated Pairs Trades when SPY and DIA daily returns diverge >0.25%, >0.50%, >0.75%
- Sold 30∆ Call in over performer and sold 30∆ Put in under performer
- Average P/L was greatest when trades were placed when divergence was >0.75% but win ratio was highest when trades were placed when divergence was >0.25%
- Pairs trading with options is historically profitable and allows us to capture divergence in two highly assets while collecting premium.