2019issue C0248-49
Pair-spread layer limits and event shocks
A pair-spread is planned as one priced relationship. Construction starts with a regime-label, then matches price, liquidity, volatility, and risk to skill and account size, with written layers, a shock-envelope, and an event-size-cut.
- Pair construction first applies a regime-label, then matches the pair-spread's price, liquidity, volatility, and risk to skill and account size.
- Layer size and total pair size follow liquidity, the six-month or one-year range, and how ATR compares with those ranges, with a shock-envelope of at least three ATRs for overnight holdings.
- Extra capital waits for a compounded-setup, an event-size-cut applies before earnings, and a range-bound plan that breaks into an opposing trend may be reduced rather than added to.
- After entry, the muted pair-spread and spread-productivity are managed, not each stock's direction, under a written concentration-cap.
One relationship, one size plan
Pair construction treats the priced relationship as the pair-spread, rather than as each stock's standalone direction. The first step is a regime-label that records whether the relationship usually stays range-bound or tends to trend.
After that label is set, the pair's price, liquidity, volatility, and risk are matched to skill and account size. Capital is not applied at one constant size. It is concentrated on higher-probability pair opportunities.
Layer-schedule from liquidity and range
Individual layer size and total pair size are set from the pair's liquidity, its six-month or one-year range, and how the ATR compares with those ranges. That written increment of size, and the cap on total layers, is the layer-schedule.
The written plan specifies size per layer, capital distribution, and total layers so the position need not be abandoned under stress. A concentration-cap forbids undue concentration in one idea.
Shock-envelope for overnight holdings
Shock planning for pairs, especially overnight holdings, is specified as at least three ATRs. That reserved capacity is the shock-envelope. Spare capital may also be reserved when an event can produce adverse excursion.
Hard-side-first and starter orders
When two symbols are correlated within the session, the harder side is generally filled first because of shorting, liquidity, or behavior. This hard-side-first sequence uses small starter orders to observe how the pair-spread behaves after a partial position.
When extra capital is considered
Additional capital is considered on a compounded-setup, including a pair at the top of its range and stretched to 100% of its ATR or ADR. A compounded-setup is present only when more than one independent stretch condition exists at the same time.
When the regime-label breaks
If a range-bound pair plan breaks into an opposing trend, adding against that move is not required. Reducing first is an allowed transition.
Event-size-cut ahead of earnings
Ahead of earnings, size is lowered and full size is not used. That planned reduction is the event-size-cut. Overnight holdings into an announcement require an explicit all-outcomes review, and spare capital may be reserved for event-driven adverse excursion.
After the pair-spread is open
Once in the trade, management watches the muted spread rather than each stock's direction. Capital is not added when the day's spread is unchanged or when spread-productivity is absent. Currency, country-focus, and sector mismatch are treated as structural red flags.
All readings on this track · 15 readings
- 1991Keep one risk ceiling after equity highs
- 1999Pre-trade size filters for expectancy and ruin
- 2000Budget the loss before entry with stops and position limits
- 2002Retest the entry before you exit
- 2002Option income after volatility and capital gates
- 2002Cap, scale, and delever when research buys late
- 2003Staying power starts as a planned-loser sizing rule
- 2006Leverage caps and concentration limits
- 2007A first-trade survival sequence for leveraged futures
- 2010Bound trend risk before the trade is placed
- 2011Event shocks, size caps, and second-order reweights
- 2014A copied scale-in ladder is not a personal risk plan
- 2018Worst-day caps for clustered system books
- 2019Pair-spread layer limits and event shocks
- 2020Pretrade quantity filters that bound account risk