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2014issue C0356

Equity and SPY stress pairs with a scaled index hedge

A pairs construction compares one equity with SPY as the market proxy. The same stress indicator can mark a relative oversold buy, a relative-advantage exit, and the scaled index hedge that lets the stock, the index, and the hedged combination be read together.

  • Pair a single equity with SPY as the market proxy and treat a relative oversold reading as the buy condition.
  • Use the same stress reading to detect when the equity no longer holds a relative advantage, and treat that loss as one of three exit triggers.
  • Control overall risk by scaling into index trades that hedge the equity transaction.
  • Show the stock, the index, and the hedged combination as three related profit-and-loss series, with the stress series plotted beside SPY and HES.
Entries in this reading3 entries
Pairs trading19 readingsCurrent trackHedging strategy25 readingsMean reversion44 readings

A stock and a market proxy

A pairs construction compares a single equity with a market proxy represented by SPY and treats a relative oversold reading as a buy condition.

The market proxy is a broad index vehicle used as the second leg of the pair. The stress indicator is the relative reading that compares the equity with that proxy to mark when the stock is stretched or no longer advantaged.

The same reading opens and closes the equity

The same stress reading is used to detect when the equity no longer holds a relative advantage versus the market.

Loss of that relative advantage is specified as one of three exit triggers for the equity holding. The relative-advantage exit fires when the equity no longer stands favorably versus the market proxy.

Hedge in stages and read three series

Overall risk is controlled by scaling into index trades that hedge the equity transaction. The scaled index hedge is an offsetting index position increased in stages to limit net exposure of the equity trade.

A profit-and-loss layout can present the stock, the index, and the hedged combination as three related series. The hedged combination is the joint profit-and-loss of the equity position and its index hedge.

A sample construction plots the stress series beside SPY and the equity HES.

Profit and loss for HES, SPY, and the hedged combination

On the published Excel book the HES long finishes near nine thousand dollars of cumulative P&L while the SPY hedge ends about four thousand in the red, so the scaled combination lands near forty-eight hundred. That three-line split is the pairs lesson: the stress-timed index hedge keeps net exposure readable beside the stock. Dollar levels were read from the Figure 14 P&L plot, not from a numeric table, and rounded to hundreds.
On the published Excel book the HES long finishes near nine thousand dollars of cumulative P&L while the SPY hedge ends about four thousand in the red, so the scaled combination lands near forty-eight hundred. That three-line split is the pairs lesson: the stress-timed index hedge keeps net exposure readable beside the stock. Dollar levels were read from the Figure 14 P&L plot, not from a numeric table, and rounded to hundreds.HES / SPY · cumulative daily P&L · 2003-01-02T00:00:00.000Z to 2013-01-02T00:00:00.000Z

Approximate readings from the raster, rounded to the nearest hundred dollars. The source workbook used a $5,000 investment, $8 commission, a 10 percent stop, and a 50 percent hedge ratio.

Educational research material, not investment advice. Historical source context does not establish present-day performance.
15 of 23 in the Hedging strategy track
201543-53 pp.Next on Hedging strategyYearly at-the-money covered calls on a dividend basketCovered call writing here means owning the shares and accepting a time-limited obligation to deliver them at a fixed strike.
All readings on this track · 23 readings
  1. 1982Basis-managed hedges and related market substitutes
  2. 1990Options as insurance unless the process is complete
  3. 1996A price-weighted technology index as a hedge and sector proxy
  4. 2002Single-stock futures as a month, margin, and hedge overlay
  5. 2004Listed volatility futures as a portfolio volatility hedge
  6. 2006Customized commodity hedges for bond and equity portfolios
  7. 2007Use of capital for overnight pairs and hedge layers
  8. 2007Opening auctions, limit envelopes, and overnight hedges
  9. 2008A two-gate intermarket test for equity bear hedges
  10. 2010Gold futures after a large setback: cluster risk and hedge timing
  11. 2011Partial commodity hedges, seasonal timing, and option income
  12. 2011Commodity-linked shares are a wrapper, a performance-bond, and a hedge-design problem
  13. 2012Hedging an open bull vertical
  14. 2012Construct a two-pair and three-pair hedge rule book
  15. 2014Equity and SPY stress pairs with a scaled index hedge
  16. 2015Yearly at-the-money covered calls on a dividend basket
  17. 2015Pair hedge to hold a valid idea through noise
  18. 2015Unused peer hedge after an ATR-qualified pair entry
  19. 2016Continuous index hedges fail the annual cost test
  20. 2016A VIX overlay as three stacked constraints
  21. 2018Late-cycle index overlay to keep equity dividends
  22. 2019Treat a bear-market hedge as a regime switch
  23. 2019Hedged pairs as game-theory payoffs
By fieldIntermarket and spreads162 readingsBy year201496 readings
All 25 readings tagged Hedging strategy
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