Options.Alpha
Short

CNQ Bear Call Spread and XOP Bull Put Spread

AMEX:XOP   SPDR S&P OIL & GAS EXPLORATION & PRODUCTION ETF
I am not sure if this is the right forum for this but anyway... Pairs trading is a statistical arbitrage strategy designed to exploit short-term deviations from a long-run equilibrium pricing relationship between two stocks . This is a well known strategy used by hedge funds and institutional investors. I have previously used pairs trading by trading two correlated stocks . Normally a trader would go long on an underperforming stock and, at the same time, go short on an outperforming stock . If properly constructed this approach eliminates net equity market exposure and the performance is then only depends on the relative performance of the two stocks . As you can see from the above chart CNQ and XOP             are correlated and move in a very similar fashion. It is not surprising as they both have very similar drivers - the price of oil             and gas. CNQ has recently been outperforming XOP             so to construct a pair trade a trader would short CNQ and go long XOP             .
For this trade I utilised stock options by selling two January 2016 credit spreads at the same time - CNQ $22/$23 Bear Call Spread for $0.26 and XOP             $27/$28 Bull Put Spread for $0.32. The total credit received from these two spreads - $0.58. The maximum risk for the trade is $1.42 per spread and the maximum return is $0.58 per spread (excl. commissions). If the spread between these tow stocks returns to mean, I should be able to profit from the trade. Let's see how this trade performs over the next 4 weeks when the Jan options expire.
Did you end up making money on this one? Looks to me like you got breached on the CNQ a week later at 22 and got breached on the XOP at 27 in Jan. Just my opinion but this is a little too close. Perhaps playing these further out would work better.
Reply
Options.Alpha SpreadEagle71
10 months ago
Hi SpreadEagle, I had Jan 15 spreads and oil really fell through the floor by then. Both CNQ and XOP followed the oil price decline and, as a result, CNQ $22/$23 bear call spread expired worthless but XOP $27/$28 bull put spread was in the money on the expiration day. So, the overall result was a loss of $0.42 ($1 spread on XOP less $0.58 credit received). The trade behaved more or less like an iron condor and to profit from the trade it required the two stocks not to move much. If I played with the same stocks as a pure pair trade (short CNQ, long XOP), then I would have made a profit as XOP declined less than CNQ but the whole idea was to use credit spreads. I will post another trade along the same lines as I like playing with spreads.
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