Pair-Trading-Model

FRE7831 Financial Analytics & Big Data term project

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Condition and Assumption:

1. Going short – the first stock of the pair is short and the other is long.
2. Going long - the first stock of the pair is long and the other is short.
3. Always trade 10,000 shares for the first stock (S1) and determine the shares for the other (S2) accordingly: N1P1 + N2P2 = 0
4. N1 and N2 are the numbers of shares of S1 and S2, and P1 and P2 are the prices of S1 and S2

Trading Algorithm:

1. Compute the standard deviation, σp, of the ratio of the two adjusted closing stock prices in each pair from 1/2/2008 to 12/31/2018. Store this standard deviation in the database.

2. The variable, k, has default value 1, but could be changed by user in the pair trading program.

3. Get Close1d1, Close2d1, Open1d2, Open2d2, Close1d2, and Close2d2, where Close1d1 and Close2d1 are the closing prices on day d–1 for stocks 1 and 2, respectively, Open1d2, Open2d2 are the opening prices for day d.

4. Open Trade:

    If abs(Close1d1/Close2d1 – Open1d2/Open2d2) >= kσ, 
        short the pair;
    Else go long the pair.
    N1 = 10,000 shares, traded at the price Open1d2, 
    N2 = N1 * (Open1d2/Open2d2), traded at the price Open2d2.

5. Close Trade: The open trades will be closed at the closing prices and P/L for the pair trade will be calculated as:

        (±N1 * [Open1d2 – Close1d2]) + (±N2 * [Open2d2 – Close2d2])

6. Use the stock daily prices from 1/2/2019 to 5/3/2019 for backtesting

7. Your program should support manually entered open and close price for a pair to simulate real-time trading

Database Schema

Create 5 tables, Pairs, Pair1Stocks, Pair2Stocks, PairPrices, Trades

• Pairs: Pair symbols, volatility, profit_loss (from back_testing),
  • primary keys: pair symbols
• Pair1Stocks and Pair2Stocks: the daily market data retrieved for each stock in the pair from 1/2/2008 to 5/3/2019
  • primary keys: symbol and date
• PairPrices: pair symbols, date, open and close price for each stock
  • primary keys: pair symbols and date
• Trades: pair symbols, date and profit_loss of each day
  • primary keys: pair symbols and date

Pair Trading Program Implementation

In the Program PairTrading.py has one function EnterPairTrade() allowing an investor to enter a pair trade. For example:

Enter a pair trade: 
ticker1: AAPL 
ticker2: HPQ 
Ticker 1 Previous Day Close Price: 606.81 
Ticker 2 Previous Day Close Price: 17.66 
Ticker 1 Open Price: 602.84 
Ticker 2 Open Price: 17.61 
Ticker 1 Close Price: 607.79 
Ticker 2 Close Price: 17.55 
AAPL HPQ 
delta = 7.14 k = 1 
vol1 = 10000 vol2 = 342328 P/L = 70039.7

The PairTrading program offers users a menu of options:

1. Select k (default k = 1). 
2. Run Back Test. 
3. Enter a Pair Trade.
4. Exit