Market Measures

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Stock Volatility 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.

Implied volatility is a difficult thing to trade exclusively. That is, this measure of options prices is tough to touch without having a bunch of other stuff in play at the same time. Today's study attempts to take market direction out of the equation by pairs trading options strategies.

The Study

After buying one strangle in the S&P 500 (SPY), we sold a notionally-equivalent number of strangles in NASDAQ (QQQ). This trade embodies a short IV bias in QQQ with a long bias in SPY's IV.

The Results

We found that pairs trading IV did indeed take some directional risk out of the trade, but it only profited when the spread between the two markets' IV was very wide.

Check out the entire study as well as Tom's input in the video above.

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