New strategies:
#261 – Trading Commodity Calendar Spreads
Period of rebalancing: monthly
Markets traded: commodities
Instruments used for trading: futures
Complexity: Complex strategy
Bactest period: 1991 – 2012
Indicative performance: 6.21%
Estimated volatility: 2.01%
Source paper:
Nikkanen: PAIRS TRADING THE COMMODITY FUTURES CURVE
http://herkules.oulu.fi/thesis/nbnfioulu-201211141056.pdf
Abstract:
I create a pairs trade on the commodity futures curve, which captures the roll returns of commodity futures and minimizes the standard deviation of the returns. The end results is a strategy that has an annualized arithmetic return of 6,04% and an annualized standard deviation of 2,01%. Transaction costs and liquidity are also accounted for. The goal was to create and backtest a trading strategy that tries to capture the roll return component of commodity futures returns. In order to reduce the very high spot price volatility of commodity returns a market neutral systematic arbitrage was introduced through a pairs trade. The pairs trade involves taking a counter position relative to the position that is designed to capture the roll return, with as small of a negative expected return as possible. In practice capturing the roll return component means taking a long position into the largest dollar difference of a backwarded futures curve. And the pairs trade component is then a short position into the same curve, but with the smallest dollar difference. If the commodity futures curve was in contango, the procedure was reverts. It can be concluded, that both of the targets of this research were reach; capturing the roll returns of the commodity futures and minimizing volatility through a statistical arbitrage pairs trade. The trades designed to capture the roll returns of commodity futures returned 5,55% annually (which was 91,9% of the portfolios total return), compared to the annualized return of the benchmark index of 0,5%. The pairs trade designed to minimize the standard deviation of these returns, lowered the annualized standard deviation of the portfolio’s returns from 6,37% to 2,01%, making it almost fully market neutral.
#262 – Timing Commodity Factor Portfolios
Period of rebalancing: daily
Markets traded: commodities
Instruments used for trading: futures
Complexity: Complex strategy
Bactest period: 1974 – 2013
Indicative performance: 10.50%
Estimated volatility: 11.30%
Source paper:
Han, Hu: Are There Exploitable Trends in Commodity Future Prices?
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2565536
Abstract:
We provide evidence that a simple moving average timing strategy, when applied to portfolios of commodity futures, can generate superior performance to the buy-and-hold strategy. The outperformance is very robust. It can survive the transaction costs in the futures markets, it is not concentrated in a particular subperiod, and it is robust to short-sale constraint, alternative specifications of the moving average lag length, and alternative construction of the continuous time-series of futures prices. The outperformance of the timing strategy is stronger during recession and with high investor sentiment, which likely proxies for high real interest rates. Finally, we confirm that the outperformance of the moving average timing strategy in the commodity futures comes from the successful timing of the market portfolio.
New research papers related to existing strategies:
#14 – Momentum Effect in Stock
Garcia-Feijoo, Jensen, Jensen: Momentum and Funding Conditions
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2572715
Abstract:
We find strong evidence linking the momentum pattern in equity returns with a prominent measure of macroeconomic conditions, specifically the funding environment. We show that the size and consistency of the momentum premium varies systematically across funding states. Furthermore, we find evidence that the relationship between momentum returns and firm characteristics (documented in previous research) is conditional on the funding environment. After controlling for the funding state, we find that the importance of market states and return dispersion disappears. Additionally, funding conditions appear to contain incremental information about the momentum premium even after adjusting for the influence of market states and return dispersion. Overall our results are consistent with the conjecture that transitions in the funding environment encourage investors to revise their portfolio allocations; this reallocation produces inter-temporal variation in the momentum return pattern.
#15 – Momentum Effect in Country Equity Indexes
Grobys: Another Look at Momentum Crashes
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2564488
Abstract:
This paper studies the profitability of a selection of prominent momentum-based strategies in the European Monetary Union. In contrast to past examples documenting the lack of profitability of unconditional price momentum in the most recent decade, the current research finds that unconditional price momentum based on intermediate past performance, as proposed in Novy-Marx (2012), yielded significantly positive payoffs. While profitability is driven by the short side of the strategy, there is no evidence of any option-like behavior. Surprisingly, the momentum strategy based on intermediate past performance generated normally distributed payoffs.
#21 – Momentum Effect in Commodities
#22 – Term Structure Effect in Commodities
Zaremba: Strategies Based on Momentum and Term Structure in Financialized Commodity Markets
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2469407
Abstract:
The aim of this paper is to investigate the impact of the financialization of commodity markets on the profitability of strategies based on momentum and term structure. The performance of an array of portfolios from double-sorts on non-commercial traders’ participation, historical returns and term spreads is tested against a risk model. Both strategies reveal better performance in case of commodity markets with low financialization level and generate little profits in the markets with a significant participation of investors. The findings of this study can be used for the purposes of tactical and strategic asset allocation.
Tree additional related research paper have been included into existing free strategy reviews during last 2 week:
#5 – FX Carry Trade
#8 – FX Momentum
Olszweski, Zhou: Strategy diversification: Combining momentum and carry strategies within a foreign exchange portfolio
http://apps.olin.wustl.edu/faculty/zhou/O_Z_JHDF_2014.pdf
Abstract:
Hedge funds, such as managed futures, typically use two different types of trading strategies: technical and macro/fundamental. In this article, we evaluate the impact of combining the two strategies, and focus on, in particular, two common foreign exchange trading strategies: momentum and carry. We find evidence that combining the strategies offers a significant improvement in risk-adjusted returns. Our analysis, which uses data spanning 20 years, highlights the potential benefits of achieving strategy-level diversification.
#12 – Pairs Trading with Stocks
Xie, Liew, Wu, Zou: Pairs Trading with Copulas
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2383185
Abstract:
Pairs trading is a well-acknowledged speculative investment strategy that is widely used in the financial markets, and distance method is the most commonly implemented pairs trading strategy by traders and hedge funds. However, this approach, which can be seen as a standard linear correlation analysis, is only able to fully describe the dependency structure between stocks under the assumption of multivariate normal returns. To overcome this limitation, we propose a new pairs trading strategy using copula modeling technique. Copula allows separate estimation of the marginal distributions of stock returns as well as their joint dependency structure. Thus, the proposed new strategy, which is based on the estimated optimal dependency structure and marginal distributions, can identify relative undervalued or overvalued positions with more accuracy and confidence. Hence, it is deemed to generate more trading opportunities and profits. A simple one-pair-one-cycle example is used to illustrate the advantages of the proposed method. Besides, a large sample analysis using the utility industry data is provided as well. The overall empirical results have verified that the proposed strategy can generate higher profits compared with the conventional distance method. We argue that the proposed trading strategy can be considered as a generalization of the conventional pairs trading strategy.
#12 – Pairs Trading with Stocks
#55 – Pairs Trading with Country ETFs
Leung, Li: Optimal Mean Reversion Trading with Transaction Costs and Stop-Loss Exit
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2222196
Abstract:
Motivated by the industry practice of pairs trading, we study the optimal timing strategies for trading a mean-reverting price spread. An optimal double stopping problem is formulated to analyze the timing to start and subsequently liquidate the position subject to transaction costs. Modeling the price spread by an Ornstein-Uhlenbeck process, we apply a probabilistic methodology and rigorously derive the optimal price intervals for market entry and exit. As an extension, we incorporate a stop-loss constraint to limit the maximum loss. We show that the entry region is characterized by a bounded price interval that lies strictly above the stop-loss level. As for the exit timing, a higher stop-loss level always implies a lower optimal take-profit level. Both analytical and numerical results are provided to illustrate the dependence of timing strategies on model parameters such as transaction cost and stop-loss level.
