LV14042

Pair Trading with Options

Jeff Donaldson, Ph.D., CFA

University of Tampa

Donald Flagg, Ph.D.

University of Tampa

Ashley Northrup
University of Tampa Student

Type of Research: Pedagogy

Disciplines of Interest: Finance and Investments

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Pair Trading with Options

Abstract

Options are an easy concept to discuss but very are very difficult one to put into practice.

In this exercise students are challenged to use different option strategies in a pair-trading

framework. With market volatility high and after the stock market fallout in 2008, pair

trading has gained much attention. Students have also become interested in this more

complex way of trading. This exercise combines the concepts of both pair trading and

options to create an experiential learning experience for students. Students will create

their own pair trade and then use an option strategy to make a pair trade. Options allow

the investor to eliminate the downside risks of a typical pair trade but also add

complexities such as time decay of option premiums. The exercise provides students with

the ability to explore option strategies in a real-world trading scenario examining

premiums over time instead of a static problem set only thinking about the valuation of

options at expiration.
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Finance students are both confused and excited about options and the use of

options. Although the initial understanding of options is achievable through traditional

lecturing and option problem sets, the real understanding of options is only understood

through the use of options in different scenarios. In this exercise, students are placed in a

real world-trading environment to test their knowledge of option strategies and witness

how these strategies work using historical option data. In this paper we integrate the use

of option strategies with the idea of pair trading.

Pair trading is not a new concept but with market volatility at all time highs, pair

trading has gained attention within the trading community and has filtered its way to the

retail investing public. With retail traders hearing more about pair trading students have

begun to gain interest in this topic as well. Pair trading is a market neutral trading

strategy, which enables traders to profit under virtually any market conditions. The

direction of the market has no apparent affect on the trade. Usually most courses in

Finance have limited coverage on pair trading. Pair trading typically involves pairing a

long position in a stock with a short position in another stock. Of course the long position

is one that an investor feels will increase and the short one is a stock the investor would

feel is inferior. Pair trading typically involves two similar firms or ETFs. Since most

investors and students are long only investors the idea of pair trading is sometimes a hard

one to grasp. Shorting a stock is sometimes thought as a more dangerous position than

being long (or owning) a stock. Theoretically this is true as a short position can lose an

infinite amount of money.

We introduce the use of options within the framework of pair trading. Trading

with options versus stock allows for different risk/return tradeoffs. Options can be used to
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limit the downside risk of the short component of the pair trade, thus making a pair trade

with options can better define the risk of downside of the pair trade, which as mentioned

above is unlimited as it relates to the short position. In the exercise students come up with

a hypothetical pair trade and then create an option strategy to take advantage of the pair

trade. One potential selection for the option trade is a straddle pair trade. This involves

the purchase of a call on the stock believed to go up and purchasing a put on the stock

believed to drop. Students can explore different option strategies and then back test their

trading strategy and the success of the pair trade by looking at the equity only returns

versus that of options from their pair trade selected.

This exercise provides students with an experiential learning method to numerous

different learning objectives. Instead of just learning about options and pair trades

students learn by developing trades and testing them. Students will analyze different

option strategies and examine investments in a pair-trading framework. Also, be able to

examine portfolio and risk management in an option framework. Finally, it allows

students to reflect on their option strategy and pair trade to measure their success in

understanding the concept of options and pair trading.

This exercise would be a particular good fit for any Investment course or in a

Financial Markets course. It could also used with currencies and currency options for an

International Finance course. This would most likely be used in a graduate course, but

could be adapted for an undergraduate course as well if simplified. This exercise would

also be a perfect compliment with the Black-Scholes model. Students can se actual option

premiums and how they are impacted by the variables within the Black-Scholes model.

As students set up a trading strategy they can see the importance of what impacts option
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premiums. This paper proceeds as follows: Section two explains the related literature.

Section three explains how to conduct the exercise and provides the instructor notes for

the exercise. Section four provides sample pair trades using options and tables showing

the results of those trades. Section five concludes.

II. Literature Review

Preston (2011) discusses the logic of the pair trade, which is to make money on

the fluctuations in price between the two stocks (or whichever instrument is used). If both

stocks increase, but the long position increases faster relative to the short position, you

will have losses on the short position and gains on the long position; the profits would

exceed the losses here if the long position were greater than the short position. The idea

he points out is that the logic of pairs trading can be quite simple, though the actual

trading can become complex. An investor needs to know the logic of the trade and

indicators he is looking for before he can make his trades successful.

He further argues that the correlation (relative strength) between the two stocks

needs to be positive. If there is a positive correlation between the two stocks and the two

stocks are correlated to the market, an increase in the market will cause a movement of

the same magnitude for each stock. For highly uncorrelated stocks, a change in the

market will not lead to the desired change and could lead to disastrous effects.

Preston’s main focus is that the pair needs to be at a higher spread than usual. It

needs to be an unusual event that an investor can take advantage of as the spread reverts

to its mean. You buy the stock that is relatively cheap, sell the stock that is relatively

expensive, and speculate that the long position will rise relative to the short position.
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Preston states that as the spread reverts “the speculation behind the pairs trade has been

met and it is wise to close it out with a profit or loss” (Traders-Mag.com, p.44). Though

these trades take much patience and knowledge, it is an opportunity to make a profit

whether the market is going up or down; just find a pair that has a spread that reverted

from its mean (prices above and below the normal range) and speculate on the trade

reverting to its mean over a period of time. Whether you are trading equities or derivative

instruments such as options, the same principles apply and profits may be realized.

Chang and Chang (2011) discuss the biases in the different methods of calculating

prices, so with a superior pricing formula, some biases should be removed. They

conclude that the information-time formula outperforms Merton’s diffusion-jump

formula in explaining Black-Scholes biases, but is less satisfactory in the case of stock

options. They suggest that transaction counts or trading volume should affect asset prices

and that information-time pricing should be a valuable alternative to the traditional

calendar-time pricing.

Gatev et al (2006) discusses the performance of pairs trading and the arbitrage

opportunities presented to investors who trade pairs. They begin by stating that the excess

returns of pairs trading are a result of temporary mispricing. In their study, they found

that the profits from the pairs they chose were uncorrelated with the S&P 500, but were

slightly sensitive to the spreads between small and large stocks and between value and

growth stocks. Their claim is that excess returns are related to the mispricing of stocks.

They showed in their research that the profits were not due simply to mean reversion

alone. In that case, one would expect the returns of both the short and the long positions
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to be equal. Thus, there are more factors than mere mean reversion to consider in a

successful pairs trade.

III. Instructor Notes / Student Exercise

Lectures of both pair trading and of options would precede this exercise. Some

extra readings can be assigned including the references in this paper to increase student

understanding. The idea of pair trading will be explained to students including explaining

how to setup a pair trade and how it works. A typical pair trade is buying one stock you

think will increase while at the same time selling a stock in a similar industry, sector, or

market direction. The design of most pair trades is to take advantage of some mispricing

or fundamental swing in prices of stocks. Students will also need to understand how

options work to make a pair trade using options.

First, students must be aware of option leverage. Each stock call option contract

purchased gives the investor the right to purchase 100 shares of stock at the given

exercise price, while a put gives the investor the right to sell 100 shares of stock at the

given exercise price. The “greeks” of options also need to be explained to students so

they understand how options are trading in a portfolio setting. First, delta or how a $1

change in stock price impacts option premiums must be explained to students. A delta of

0.50 signifies that a dollar increase in stock price leads to an increase of 50 cents in the

option premium. When picking the options to use students can use delta to determine the

ratio of calls and puts to use if a delta strategy is desired, similar to a Beta neutral strategy

for an all equity pair trade. Gamma (first derivative of delta) or the rate at which delta
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increases or decreases can be used as well for the students to further develop their option

strategy.

Next, students should examine theta or time premium decay. This shows how fast

the time premium of the option reduces or decays over time. This is important because

when purchasing calls and puts as time passes the option time premium approaches zero.

Thus, options with longer time periods have higher premiums and those premiums decay

as you approach expiration. Next, vega or the how volatility impacts option prices. As

volatility of the underlining stock increases so does option premiums on that stock. With

all else equal, the option premium increases in value when the implied volatility of the

underlying stock increases. So, even with no price movement in the underlining stock the

option will move down with time and can move up and down with changes in volatility.

The option strategy summary is shown in figure 1, which can be provided to students.

OPTION GREEKS SUMMARY – Figure 1

Delta How stock price changes impact option premiums
Gamma First derivative of delta (the rate at which delta increases or decreases)
Theta Time premium decay (how fast the time premium decays over time)
Vega How the option premium will change with changes in implied volatility of the stock

Exercise Explained

After explaining about pair trading and options, students will be instructed to

think of an interesting pair trade with stocks. Next, the students will have to create an

option strategy to take advantage of the pair trade such as a spread or straddle. Students

should motivate the option strategy used by explaining how the strategy works and how it

will be used to maximize returns or limit downside risks. For example a straddle limits

the investors potential loss if the trade goes down but also is expensive in terms of time
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period decay (the theta discussed earlier). Third, students will set a time period for their

trade in terms of how long they will have the trade for. Fourth, students are given the raw

data to calculate the profit or loss of trade(s) over the selected time period. The dates of

this data (annual or two years) can be given beforehand or hidden so students do not

know the results before picking a strategy. Either way is interesting as either students

think they have a good or bad strategy based on stock returns and will see the impact of

an option trade or will be surprised both by the equity only pair trade and the option pair

trade. Students will see how their option strategy traded over the time period. The time

period for the pair trade can be months or years depending on the preference of the

instructor and the purpose of the trade.

Discussion Questions

1. Explain theoretically when your option strategy should do well and when it would

do poorly. Discuss other option strategies that could be used.

2. Gather the stock returns for both stocks over a three-year time period. Analyze the

pair trade based solely on equity returns. Base gains and losses on a hypothetical

$500,000 portfolio.

3. Discuss why the leverage, VIX (proxy for vega), time premium (or theta), and

stock price movement in comparison to the stock (delta) is important to the

premiums of options. How do these affect whether you pick in-the-money, out-of-

the-money, or at-the-money options?

4. Gather and calculate your option performance and measure it against that of the

equity holdings, VIX, and S&P 500.

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5. Discuss how the option strategy worked and how it is different for an all equity

pair trade.

6. In this particular exercise, we already know the performance of stocks and options

beforehand. Based on the results what type of trade (stock or option) would you

use in the future if you were going to make a pair trade?

Answers to Discussion Questions

1. Explain theoretically when your option strategy should do well and when it would

do poorly.

Students should answer this question by discussing their option strategy and how

it should work theoretically work in different scenarios. For example if the

student selected a straddle (buying both a call and put), they should comment on

the cost of the straddle and how no movement in the stock would be bad for this

strategy even outside of the normal pair trade. Also, if each stock moved up a lot

or down a lot than the straddle would be a good trade even if the pair trade part

of the trade did work well. This is a good point of the exercise for the students to

first think about what might happen and then see what happens with the data.

2. Discuss why the leverage, VIX (proxy for vega), time premium (or theta), and

option price movement in comparison to the underlining stock (delta) is important

to the premiums of options. How do these affect whether you pick in-the-money,

out-of-the-money, or at-the-money options?

Students should define all items listed in question 2, similar to what was written

under the instructor notes. Students should also discuss the concept of in-the-

money, out-of-the-money, and at-the-money. Students should link together the

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fact that out-of-the money options have the smallest deltas but can have the

largest percentage moves, and the opposite with in-the-money options.

3. Analyze the pair trade based solely on equity returns. Base gains and losses on a

hypothetical $500,000 portfolio. Gather and calculate your option performance

and measure it against that of the equity holdings, VIX, and S&P 500.

An example of pair trades that could be selected is included in the section titled

sample pair trades and in the tables below. These trades are three year in

duration, which may be much longer than the duration chosen by students, but

provide an example of a potential trade.

4. Discuss how the option strategy worked and how it is different for an equity pair

trade.

Students should analyze the returns of the equity portfolio versus that of the

option portfolio and provide some analysis between the two. An example of this is

shown in the sample pair trades section and tables below. Students should also

discuss how the option strategy selected worked and how it was different from an

equity pair trade.

5. Based on the results what type of trade (stock or option) would you use in the

future if you were going to make a pair trade? How could the information from

the exercise impact your future trading? How did this exercise increase your

understanding of pair trading and options?

Students should respond with a reflection type answer for this question. After the

completion of the exercise students should discuss how their understanding has

increased and list of couple of things they learned through the exercise. For
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example students could discuss how pair trading with options using a straddle

strategy makes volatility almost more important than the quality of the pair trade.

Students may also address how time decay of options and how it is important to

trade options before they expire, discussing the rolling of shorter term options to

capture the pair trade over several months or years.

IV. Sample Pair Trades

The tables show four pair trades pair trades created by students: long AAPL, short

RIMM; long HD, short LOW; long QQQ, short SPY; and long DIA, short SPY. Call

options were purchased for AAPL, HD, QQQ, and DIA; put options were purchased for

RIMM, LOW, and SPY. From 2008 through 2010, Apple experienced a phenomenal

increase in price, while Research in Motion experienced a phenomenal decline in price;

as one might expect, this would lead to great profits with this pair trade, as will be shown

later. Home Depot experienced a high growth rate, being priced around 63% higher at the

end of 2010 versus the beginning of 2008; Lowe’s experienced growth, but much lower

around 3% higher over the three-year period. For consistency, both indexes were paired

against the S&P 500 index; the NASDAQ trade fared much better than the Dow Jones

trade.

Data Used For Sample Pair Trades

Data was collected from a pool of options data from 2008 through 2010. This was

the time period of data used but this can be adjusted to fit the duration selected by both

the instructor and the students. Among the collected information was the underlying

stock price, the strike price, bid and ask beginning price, bid and ask ending price, and
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the delta of each option. For the month of January 2008, the purchase would be options

expiring in February 2008; the options would be purchased at the beginning of the month

and exercised at the end of the month. For February 2008, it would be options expiring in

March 2008; the options would be purchased at the end of January and exercised at the

end of February. An amount of $50,000 was allocated to each pair trade; each month

$50,000 was reinvested into each pair trade. This was compared to holding only stock the

entire time. Options pair trades were adjusted for delta, as it tracks the change in the

option price with the change in the underlying stock. For trades holding stock only,

adjustments for beta were made. The options-only strategy was then compared to the

stock-only strategy.

V. Conclusion

Experiential learning is on the rise and it has been shown that students will retain

things longer after putting them into practice. Options are traditional an easy concept to

discuss but students never seem to fully understand the idea of options and how they are

traded. This exercise gives students the opportunity to use options in practice and

formulate a trading strategy. The exercise increase students understanding and retention

of options and pair trading while at the same time provides them with a real-world

trading experience.
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Table 1: Long AAPL, Short RIMM

Stock
Date Options Returns Difference S&P Absolute ∆ VIX VIX ∆
Returns
Jan '08 $ 14,798.00 29.60% -14.45% 44.05% -6.12% 6.12% 17.75 16.44%
Feb '08 $ (39,418.00) -78.84% -18.21% -60.63% -3.48% 3.48% 23.54 1.30%
Mar '08 $ 23,864.00 47.73% 6.66% 41.07% -0.60% 0.60% 21.20 -3.50%
Apr '08 $ 77,395.00 154.79% 12.84% 141.95% 4.75% 4.75% 23.70 -18.82%
May '08 $ (19,054.00) -38.11% -5.67% -32.44% 1.07% 1.07% 26.05 -14.24%
June '08 $ (3,560.00) -7.12% 4.53% -11.65% -8.60% 8.60% 23.50 34.32%
July '08 $ (29,020.00) -58.04% -10.13% -47.91% -0.99% 0.99% 34.54 -4.22%
Aug '08 $ (2,235.00) -4.47% 7.65% -12.12% 1.22% 1.22% 32.07 -9.98%
Sept '08 $ 89,037.00 178.07% 10.88% 167.20% -9.08% 9.08% 22.05 90.75%
Oct '08 $ 7,415.00 14.83% 20.82% -5.99% -16.94% 16.94% 17.59 52.04%
Nov '08 $ 8,315.00 16.63% 1.92% 14.71% -7.48% 7.48% 19.50 -7.70%
Dec '08 $ (34,752.00) -69.50% -3.45% -66.06% 0.78% 0.78% 24.62 -27.64%
Jan '09 $ (38,400.00) -76.80% -30.92% -45.88% -8.57% 8.57% 21.68 12.10%
Feb '09 $ 76,860.00 153.72% 27.00% 126.72% -10.99% 10.99% 24.51 3.37%
Mar '09 $ 21,340.00 42.68% 9.77% 32.91% 8.54% 8.54% 30.69 -4.77%
Apr '09 $ 5,800.00 11.60% -41.51% 53.11% 9.39% 9.39% 25.61 -17.31%
May '09 $ (6,996.00) -13.99% -5.22% -8.77% 5.31% 5.31% 26.01 -20.77%
June '09 $ 13,540.00 27.08% 14.48% 12.60% 0.02% 0.02% 25.92 -8.89%
July '09 $ 29,895.00 59.79% 7.82% 51.97% 7.41% 7.41% 26.35 -1.63%
Aug '09 $ (11,740.00) -23.48% 6.81% -30.29% 3.36% 3.36% 28.92 0.35%
Sept '09 $ 31,040.00 62.08% 17.62% 44.46% 3.57% 3.57% 36.50 -1.54%
Oct '09 $ 54,840.00 109.68% 14.86% 94.82% -1.98% 1.98% 44.14 19.84%
Nov '09 $ (16,712.00) -33.42% 7.48% -40.91% 5.74% 5.74% 46.35 -20.14%
Dec '09 $ (6,045.00) -12.09% -11.26% -0.83% 1.78% 1.78% 44.84 -11.55%
Jan '10 $ (25,073.00) -50.15% -2.00% -48.14% -3.70% 3.70% 40.00 13.56%
Feb '10 $ (8,331.00) -16.66% -6.13% -10.53% 2.85% 2.85% 55.28 -20.80%
Mar '10 $ 45,066.00 90.13% 10.49% 79.64% 5.88% 5.88% 59.89 -9.79%
Apr '10 $ 36,958.00 73.92% 14.86% 59.06% 1.48% 1.48% 39.39 25.36%
May '10 $ 67,554.00 135.11% 13.14% 121.97% -8.20% 8.20% 20.65 45.44%
June '10 $ 17,550.00 35.10% 16.75% 18.35% -5.39% 5.39% 22.94 7.70%
July '10 $ (26,103.00) -52.21% -14.51% -37.69% 6.88% 6.88% 23.95 -31.96%
Aug '10 $ 36,520.00 73.04% 20.03% 53.01% -4.74% 4.74% 17.83 10.85%
Sept '10 $ 30,915.00 61.83% 3.07% 58.76% 8.76% 8.76% 20.79 -9.02%
Oct '10 $ (9,808.00) -19.62% -10.83% -8.79% 3.69% 3.69% 25.61 -10.55%
Nov '10 $ (17,870.00) -35.74% -5.25% -30.49% -0.23% 0.23% 26.54 11.04%
Dec '10 $ 3,595.00 7.19% 9.65% -2.46% 6.53% 6.53% 26.20 -24.60%

Sum $ 397,180.00 794.36% 79.58% 714.78% -8.07% 186.06% 1046.7 65.06%

Average $ 11,032.78 22.07% 2.21% 19.86% -0.22% 5.17% 29.08 1.81%
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Table 2: Long HD, Short LOW

Stock
Date Options Returns Difference S&P Absolute ∆ VIX VIX ∆
Returns
Jan '08 $ 7,285.00 14.57% -3.59% 18.16% -6.12% 6.12% 17.75 16.44%
Feb '08 $ (25,800.00) -51.60% -4.00% -47.60% -3.48% 3.48% 23.54 1.30%
Mar '08 $ 17,196.00 34.39% 10.56% 23.83% -0.60% 0.60% 21.20 -3.50%
Apr '08 $ (32,605.00) -65.21% -7.18% -58.03% 4.75% 4.75% 23.70 -18.82%
May '08 $ (11,536.00) -23.07% -0.27% -22.80% 1.07% 1.07% 26.05 -14.24%
June '08 $ 9,022.00 18.04% -0.16% 18.21% -8.60% 8.60% 23.50 34.32%
July '08 $ (16,635.00) -33.27% 3.38% -36.65% -0.99% 0.99% 34.54 -4.22%
Aug '08 $ 28,118.00 56.24% -7.48% 63.71% 1.22% 1.22% 32.07 -9.98%
Sept '08 $ 10,412.00 20.82% 0.13% 20.70% -9.08% 9.08% 22.05 90.75%
Oct '08 $ (4,884.00) -9.77% -0.89% -8.88% -16.94% 16.94% 17.59 52.04%
Nov '08 $ (11,570.00) -23.14% 2.77% -25.91% -7.48% 7.48% 19.50 -7.70%
Dec '08 $ (16,245.00) -32.49% -3.50% -28.99% 0.78% 0.78% 24.62 -27.64%
Jan '09 $ 7,428.00 14.86% 8.31% 6.54% -8.57% 8.57% 21.68 12.10%
Feb '09 $ 16,876.00 33.75% 10.31% 23.44% -10.99% 10.99% 24.51 3.37%
Mar '09 $ 16,576.00 33.15% -1.10% 34.25% 8.54% 8.54% 30.69 -4.77%
Apr '09 $ (14,566.00) -29.13% -6.53% -22.60% 9.39% 9.39% 25.61 -17.31%
May '09 $ (27,802.00) -55.60% -0.42% -55.18% 5.31% 5.31% 26.01 -20.77%
June '09 $ (23,317.00) -46.63% 0.85% -47.49% 0.02% 0.02% 25.92 -8.89%
July '09 $ 9,081.00 18.16% -6.47% 24.64% 7.41% 7.41% 26.35 -1.63%
Aug '09 $ 12,285.00 24.57% 9.50% 15.07% 3.36% 3.36% 28.92 0.35%
Sept '09 $ (23,730.00) -47.46% 1.01% -48.47% 3.57% 3.57% 36.50 -1.54%
Oct '09 $ (19,586.00) -39.17% 0.29% -39.46% -1.98% 1.98% 44.14 19.84%
Nov '09 $ 11,522.00 23.04% -2.38% 25.43% 5.74% 5.74% 46.35 -20.14%
Dec '09 $ (22,981.00) -45.96% -0.62% -45.34% 1.78% 1.78% 44.84 -11.55%
Jan '10 $ (10,570.00) -21.14% 3.91% -25.05% -3.70% 3.70% 40.00 13.56%
Feb '10 $ 15,897.00 31.79% 1.90% 29.90% 2.85% 2.85% 55.28 -20.80%
Mar '10 $ (13,162.00) -26.32% 2.22% -28.54% 5.88% 5.88% 59.89 -9.79%
Apr '10 $ 36,082.00 72.16% -3.40% 75.56% 1.48% 1.48% 39.39 25.36%
May '10 $ 19,869.00 39.74% 4.87% 34.86% -8.20% 8.20% 20.65 45.44%
June '10 $ 33,835.00 67.67% 0.99% 66.68% -5.39% 5.39% 22.94 7.70%
July '10 $ (22,245.00) -44.49% -0.57% -43.92% 6.88% 6.88% 23.95 -31.96%
Aug '10 $ (29,063.00) -58.13% 0.62% -58.75% -4.74% 4.74% 17.83 10.85%
Sept '10 $ 32,177.00 64.35% 3.95% 60.40% 8.76% 8.76% 20.79 -9.02%
Oct '10 $ (12,592.00) -25.18% 1.29% -26.48% 3.69% 3.69% 25.61 -10.55%
Nov '10 $ (21,693.00) -43.39% -7.83% -35.56% -0.23% 0.23% 26.54 11.04%
Dec '10 $ (39,272.00) -78.54% 5.56% -84.10% 6.53% 6.53% 26.20 -24.60%

Sum $ (116,193.00) -232.39% 16.04% -248.43% -8.07% 186.06% 1046.70 65.06%

Average $ (3,227.58) -6.46% 0.45% -6.90% -0.22% 5.17% 29.08 1.81%
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Table 3: Long QQQ, Short SPY

Date Options Returns Stock Returns Difference S&P Absolute ∆ VIX VIX ∆
Jan '08 $ (13,447.00) -26.89% -5.83% -21.06% -6.12% 6.12% 17.75 16.44%
Feb '08 $ 41,083.00 82.17% -2.26% 84.42% -3.48% 3.48% 23.54 1.30%
Mar '08 $ (23,226.00) -46.45% 2.78% -49.23% -0.60% 0.60% 21.20 -3.50%
Apr '08 $ 2,652.00 5.30% 3.21% 2.10% 4.75% 4.75% 23.70 -18.82%
May '08 $ (5,828.00) -11.66% 4.42% -16.08% 1.07% 1.07% 26.05 -14.24%
June '08 $ 24,703.00 49.41% -1.26% 50.67% -8.60% 8.60% 23.50 34.32%
July '08 $ (23,125.00) -46.25% 1.53% -47.78% -0.99% 0.99% 34.54 -4.22%
Aug '08 $ (20,782.00) -41.56% -0.08% -41.49% 1.22% 1.22% 32.07 -9.98%
Sept '08 $ 25,767.00 51.53% -6.16% 57.70% -9.08% 9.08% 22.05 90.75%
Oct '08 $ 31,820.00 63.64% 1.05% 62.59% -16.94% 16.94% 17.59 52.04%
Nov '08 $ 16,890.00 33.78% -4.50% 38.28% -7.48% 7.48% 19.50 -7.70%
Dec '08 $ (10,143.00) -20.29% 1.28% -21.56% 0.78% 0.78% 24.62 -27.64%
Jan '09 $ 13,288.00 26.58% 5.94% 20.64% -8.57% 8.57% 21.68 12.10%
Feb '09 $ 20,748.00 41.50% 5.47% 36.03% -10.99% 10.99% 24.51 3.37%
Mar '09 $ 11,187.00 22.37% 2.01% 20.37% 8.54% 8.54% 30.69 -4.77%
Apr '09 $ 7,837.00 15.67% 3.13% 12.54% 9.39% 9.39% 25.61 -17.31%
May '09 $ (16,374.00) -32.75% -2.63% -30.12% 5.31% 5.31% 26.01 -20.77%
June '09 $ (14,678.00) -29.36% 3.00% -32.36% 0.02% 0.02% 25.92 -8.89%
July '09 $ 9,100.00 18.20% 0.98% 17.22% 7.41% 7.41% 26.35 -1.63%
Aug '09 $ (22,652.00) -45.30% -2.22% -43.09% 3.36% 3.36% 28.92 0.35%
Sept '09 $ (9,301.00) -18.60% 2.11% -20.71% 3.57% 3.57% 36.50 -1.54%
Oct '09 $ (20,400.00) -40.80% -1.14% -39.66% -1.98% 1.98% 44.14 19.84%
Nov '09 $ (1,366.00) -2.73% 0.18% -2.91% 5.74% 5.74% 46.35 -20.14%
Dec '09 $ (970.00) -1.94% 3.30% -5.24% 1.78% 1.78% 44.84 -11.55%
Jan '10 $ (6,248.00) -12.50% -2.83% -9.67% -3.70% 3.70% 40.00 13.56%
Feb '10 $ (4,579.00) -9.16% 1.49% -10.65% 2.85% 2.85% 55.28 -20.80%
Mar '10 $ 6,388.00 12.78% 2.05% 10.73% 5.88% 5.88% 59.89 -9.79%
Apr '10 $ 1,030.00 2.06% 0.71% 1.35% 1.48% 1.48% 39.39 25.36%
May '10 $ 60,969.00 121.94% 0.54% 121.39% -8.20% 8.20% 20.65 45.44%
June '10 $ (17,282.00) -34.56% -0.97% -33.59% -5.39% 5.39% 22.94 7.70%
July '10 $ 3,270.00 6.54% 0.43% 6.11% 6.88% 6.88% 23.95 -31.96%
Aug '10 $ (12,464.00) -24.93% -0.63% -24.29% -4.74% 4.74% 17.83 10.85%
Sept '10 $ 27,218.00 54.44% 4.22% 50.21% 8.76% 8.76% 20.79 -9.02%
Oct '10 $ 8,820.00 17.64% 2.51% 15.13% 3.69% 3.69% 25.61 -10.55%
Nov '10 $ (17,492.00) -34.98% -0.17% -34.81% -0.23% 0.23% 26.54 11.04%
Dec '10 $ (12,460.00) -24.92% -1.93% -22.99% 6.53% 6.53% 26.20 -24.60%

Sum $ 59,953.00 119.91% 19.70% 100.20% -8.07% 186.06% 1046.70 65.06%

Average $ 1,665.36 3.33% 0.55% 25.35% -0.44% 10.06% 29.08 1.81%
 LV14042 Table 4: Long DIA, Short SPY
Stock
Date Options Returns Difference S&P Absolute ∆ VIX VIX ∆
Returns
Jan '08 $ (12,105.00) -24.21% 1.22% -25.43% -6.12% 6.12% 17.75 16.44%
Feb '08 $ 48,654.00 97.31% 0.40% 96.91% -3.48% 3.48% 23.54 1.30%
Mar '08 $ (32,362.00) -64.72% 0.64% -65.36% -0.60% 0.60% 21.20 -3.50%
Apr '08 $ (17,611.00) -35.22% 0.09% -35.31% 4.75% 4.75% 23.70 -18.82%
May '08 $ (24,192.00) -48.38% -2.86% -45.52% 1.07% 1.07% 26.05 -14.24%
June '08 $ 21,984.00 43.97% -1.52% 45.48% -8.60% 8.60% 23.50 34.32%
July '08 $ (19,380.00) -38.76% 1.29% -40.05% -0.99% 0.99% 34.54 -4.22%
Aug '08 $ (17,225.00) -34.45% 0.22% -34.67% 1.22% 1.22% 32.07 -9.98%
Sept '08 $ 36,210.00 72.42% 3.55% 68.87% -9.08% 9.08% 22.05 90.75%
Oct '08 $ 32,220.00 64.44% 2.96% 61.48% -16.94% 16.94% 17.59 52.04%
Nov '08 $ 16,260.00 32.52% 1.82% 30.70% -7.48% 7.48% 19.50 -7.70%
Dec '08 $ (19,409.00) -38.82% -1.55% -37.27% 0.78% 0.78% 24.62 -27.64%
Jan '09 $ 9,068.00 18.14% -0.14% 18.27% -8.57% 8.57% 21.68 12.10%
Feb '09 $ 16,335.00 32.67% -0.46% 33.13% -10.99% 10.99% 24.51 3.37%
Mar '09 $ 11,373.00 22.75% -0.89% 23.63% 8.54% 8.54% 30.69 -4.77%
Apr '09 $ (16,029.00) -32.06% -2.06% -29.99% 9.39% 9.39% 25.61 -17.31%
May '09 $ (9,745.00) -19.49% -0.99% -18.50% 5.31% 5.31% 26.01 -20.77%
June '09 $ (24,475.00) -48.95% -0.47% -48.48% 0.02% 0.02% 25.92 -8.89%
July '09 $ 20,506.00 41.01% 0.98% 40.03% 7.41% 7.41% 26.35 -1.63%
Aug '09 $ (14,287.00) -28.57% 0.36% -28.93% 3.36% 3.36% 28.92 0.35%
Sept '09 $ (18,876.00) -37.75% -1.22% -36.54% 3.57% 3.57% 36.50 -1.54%
Oct '09 $ (7,940.00) -15.88% 1.99% -17.87% -1.98% 1.98% 44.14 19.84%
Nov '09 $ 10,962.00 21.92% 0.91% 21.02% 5.74% 5.74% 46.35 -20.14%
Dec '09 $ (31,372.00) -62.74% -1.05% -61.69% 1.78% 1.78% 44.84 -11.55%
Jan '10 $ (8,050.00) -16.10% 0.25% -16.35% -3.70% 3.70% 40.00 13.56%
Feb '10 $ (15,834.00) -31.67% -0.12% -31.54% 2.85% 2.85% 55.28 -20.80%
Mar '10 $ 10,302.00 20.60% -0.51% 21.11% 5.88% 5.88% 59.89 -9.79%
Apr '10 $ (9,095.00) -18.19% -0.10% -18.09% 1.48% 1.48% 39.39 25.36%
May '10 $ 56,998.00 114.00% 0.46% 113.54% -8.20% 8.20% 20.65 45.44%
June '10 $ (14,520.00) -29.04% 1.66% -30.70% -5.39% 5.39% 22.94 7.70%
July '10 $ 13,600.00 27.20% 0.40% 26.80% 6.88% 6.88% 23.95 -31.96%
Aug '10 $ (11,481.00) -22.96% 0.56% -23.52% -4.74% 4.74% 17.83 10.85%
Sept '10 $ (293.00) -0.59% -1.07% 0.49% 8.76% 8.76% 20.79 -9.02%
Oct '10 $ (18,124.00) -36.25% -0.59% -35.66% 3.69% 3.69% 25.61 -10.55%
Nov '10 $ (18,450.00) -36.90% -0.70% -36.20% -0.23% 0.23% 26.54 11.04%
Dec '10 $ (12,087.00) -24.17% -1.49% -22.68% 6.53% 6.53% 26.20 -24.60%

Sum $ (68,470.00) -136.94% 1.96% -138.90% -8.07% 186.06% 1046.7 65.06%

Average $ (1,901.94) -3.80% 0.05% -3.86% -0.22% 5.17% 29.075 1.81%
LV14042

Table 5: Summary of Trades

Date Options % Stocks Difference S&P Absolute ∆ VIX VIX ∆
Jan '08 $ (3,469.00) -1.73% -22.65% 20.92% -6.12% 6.12% 17.75 16.44%
Feb '08 $ 24,519.00 12.26% -24.06% 36.32% -3.48% 3.48% 23.54 1.30%
Mar '08 $ (14,528.00) -7.26% 20.64% -27.91% -0.60% 0.60% 21.20 -3.50%
Apr '08 $ 29,831.00 14.92% 8.96% 5.96% 4.75% 4.75% 23.70 -18.82%
May '08 $ (60,610.00) -30.31% -4.38% -25.93% 1.07% 1.07% 26.05 -14.24%
June '08 $ 52,149.00 26.07% 1.59% 24.48% -8.60% 8.60% 23.50 34.32%
July '08 $ (88,160.00) -44.08% -3.93% -40.15% -0.99% 0.99% 34.54 -4.22%
Aug '08 $ (12,124.00) -6.06% 0.31% -6.37% 1.22% 1.22% 32.07 -9.98%
Sept '08 $ 161,426.00 80.71% 8.39% 72.32% -9.08% 9.08% 22.05 90.75%
Oct '08 $ 66,571.00 33.29% 23.94% 9.34% -16.94% 16.94% 17.59 52.04%
Nov '08 $ 29,895.00 14.95% 2.01% 12.94% -7.48% 7.48% 19.50 -7.70%
Dec '08 $ (80,549.00) -40.27% -7.22% -33.06% 0.78% 0.78% 24.62 -27.64%
Jan '09 $ (8,616.00) -4.31% -16.81% 12.50% -8.57% 8.57% 21.68 12.10%
Feb '09 $ 130,819.00 65.41% 42.31% 23.10% -10.99% 10.99% 24.51 3.37%
Mar '09 $ 60,476.00 30.24% 9.78% 20.45% 8.54% 8.54% 30.69 -4.77%
Apr '09 $ (16,958.00) -8.48% -46.98% 38.50% 9.39% 9.39% 25.61 -17.31%
May '09 $ (60,917.00) -30.46% -9.26% -21.20% 5.31% 5.31% 26.01 -20.77%
June '09 $ (48,930.00) -24.47% 17.86% -42.33% 0.02% 0.02% 25.92 -8.89%
July '09 $ 68,582.00 34.29% 3.31% 30.98% 7.41% 7.41% 26.35 -1.63%
Aug '09 $ (36,394.00) -18.20% 14.45% -32.65% 3.36% 3.36% 28.92 0.35%
Sept '09 $ (20,867.00) -10.43% 19.52% -29.95% 3.57% 3.57% 36.50 -1.54%
Oct '09 $ 6,914.00 3.46% 16.00% -12.55% -1.98% 1.98% 44.14 19.84%
Nov '09 $ 4,406.00 2.20% 6.19% -3.99% 5.74% 5.74% 46.35 -20.14%
Dec '09 $ (61,368.00) -30.68% -9.63% -21.05% 1.78% 1.78% 44.84 -11.55%
Jan '10 $ (49,941.00) -24.97% -0.68% -24.29% -3.70% 3.70% 40.00 13.56%
Feb '10 $ (12,847.00) -6.42% -2.86% -3.56% 2.85% 2.85% 55.28 -20.80%
Mar '10 $ 48,594.00 24.30% 14.24% 10.05% 5.88% 5.88% 59.89 -9.79%
Apr '10 $ 64,975.00 32.49% 12.08% 20.41% 1.48% 1.48% 39.39 25.36%
May '10 $ 205,390.00 102.70% 19.01% 83.68% -8.20% 8.20% 20.65 45.44%
June '10 $ 19,583.00 9.79% 18.43% -8.64% -5.39% 5.39% 22.94 7.70%
July '10 $ (31,478.00) -15.74% -14.26% -1.48% 6.88% 6.88% 23.95 -31.96%
Aug '10 $ (16,488.00) -8.24% 20.59% -28.83% -4.74% 4.74% 17.83 10.85%
Sept '10 $ 90,017.00 45.01% 10.17% 34.84% 8.76% 8.76% 20.79 -9.02%
Oct '10 $ (31,704.00) -15.85% -7.62% -8.24% 3.69% 3.69% 25.61 -10.55%
Nov '10 $ (75,505.00) -37.75% -13.96% -23.80% -0.23% 0.23% 26.54 11.04%
Dec '10 $ (60,224.00) -30.11% 11.79% -41.90% 6.53% 6.53% 26.20 -24.60%

Sum $ 272,470.00 136.24% 117.28% 18.95% -8.07% 186.06% 1046.70 65.06%

Average $ 7,568.61 3.78% 3.26% 0.53% -0.22% 5.17% 29.08 1.81%
LV14042

References

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and Futures. Hoboken, New Jersey: John Wiley and Sons, Inc., 2006. Print.

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Performance of a Relative-Value Arbitrage Rule.” The Review of Financial

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13 December 2011.