Preface ix
Chapter 1 Uncertainty 1
Impact on Trading 2
The Inevitable Price Shocks 3
Why So Much about Price Shocks? 9
Complexity and Contagion Risk 10
The Ugly Side 11
Taking Defensive Action 11
Accepting Performance for What it is 13
Chapter 2 The Importance of Price Noise 15
Noise Explained 15
Different Markets 19
A Closer Look at Equity Index Markets 21
Importance of Noise 22
Determining the Strategy 25
Capitalizing on the Trend of Noise 29
Chapter 3 Pairs Trading: Understanding the Process 31
The Process 32
The Basics 32
Target Volatility 54
Home Builders 65
Using ETFs 78
Portfolio of Home Builder Pairs 84
Execution and the Part-Time Trader 89
Stop-Losses 89
Trading Intraday 90
Key Points to Remember 90
Chapter 4 Pairs Trading Using Futures 93
Futures 94
Mechanics of a Pairs Trade in Futures 97
Inflation Scares 100
Trading Energy Pairs 102
Revisiting Momentum with Energy Markets 105
A Miniportfolio of Natural Gas Pairs 112
The Inflation Pairs: Crude, the EURUSD, and Gold 119
Equity Index Pairs 128
Leveraging with Futures 138
London Metals Exchange Pairs 141
Volatility Filters 153
Interest Rate Futures 154
Summary 154
Chapter 5 Risk-Adjusted Spreads 155
Dell and Hewlett-Packard 155
Trading Both Long-Term (Hedged) Trends and Short-Term Mean Reversion 159
Gold, Platinum, and Silver 161
The Platinum/Gold Ratio 163
Implied Yield 170
The Yield Curve 174
Trend Trading of London Metal Exchange Pairs 179
Summary 184
Chapter 6 Cross-Market Trading and the Stress Indicator 187
The Crossover Trade 188
The Stress Indicator 189
Gold, Copper, and Platinum 195
Mining Companies 198
Agribusiness Pairs 206
The Major Energy Producers 208
Portfolio of Cross-Market Energy Pairs 220
Other Opportunities 226
Some Final Notes 228
Chapter 7 Revisiting Pairs Using the Stress Indicator 229
Futures Markets and the Stress Indicator 229
Equity Index Futures 230
Interest Rate Futures 238
The Portfolio Spreadsheet 245
Summary of Pairs Trading 248
Chapter 8 Traditional Market-Neutral Trading 249
Home Builders 250
Trend or Mean Reversion? 250
Basic Market-Neutral Concept 251
Volatility-Adjusting the Position Size 264
Arbing the Dow: A Large-Scale Program 267
Thoughts about Market-Neutral Trend Following 274
Market Neutral Using Futures 274
Market-Neutral Comments 277
Chapter 9 Other Stat-Arb Methods 281
Trade-Offs 282
System Briefs 282
New Highs and New Lows 290
Merger Arb 290
Creating Your Own Index Arbitrage 292
Arbing the Dow 301
Arbing the S&P 500-Index Arbitrage 302
About the Companion Web Site 305
About the Author 306
Index 307
