Calculating Returns on a Pairs Trade with Long and Short Legs

Summary

The document presents a two-day example of a pairs trade that goes long one stock and short another, using roughly equal dollar amounts in each leg. It calculates the opening and closing cash flows from the share quantities and prices, then adds them to estimate the trade’s dollar profit or loss. The example also reports the ratio between the two stock prices at entry and exit.

The question asks how to convert that dollar result into a percentage return, but it provides no answer or chosen denominator. A percentage requires a defined capital base, and the appropriate base depends on how the short sale proceeds, margin, collateral, and funding are handled. The example’s net cash flow at entry is not necessarily the capital committed to the position. It also omits transaction costs, dividends, borrow fees, and other financing effects, so its stated profit calculation is incomplete as a measure of realized strategy performance.

Key ideas

• The example opens a pairs trade by buying one stock and shorting another in roughly equal dollar amounts.
• The dollar profit or loss is calculated by combining the cash flows from both legs at entry and exit.
• A percentage return depends on the capital base chosen for the trade.
• Short sale proceeds, margin, financing, transaction costs, and dividends can affect the return calculation.

Tags

# Calculating % Return in Pairs Trading Strategy


# Calculating % Return in Pairs Trading Strategy












Hi guys Could you help me here?

I would like to calculate the return of a Pairs Trading strategy. For example:

18/11 - Open the Trade: I will go long on A and Short on B:

Stock A : $ 32.24 Stock B : $ 29.82

Ratio: $\frac{(Price of StockA)}{(Price of StockB)} = 1,0812$

I will buy: $\frac{($30.000)}{32.24} = 900$ (approximately)) units of Stock A. The cost is: $900*32.24 = \$29,016.00$

And Sell: $\frac{($30.000)}{29.82} = 1000$ (approximately)) units of Stock B : $ = 1000*29.82 = \$29,820.00$

The Cost of Open the Trade:$ \$29,820.00 - \$29,016.00 = \$804 $

At 20/11 I will Close the Trade:

Price of Stock A At 20/11: $ \$32.63$ Price of Stock B At 20/11: $ \$30.08$

Ratio: $\frac{(Price of StockA)}{Price of StockB} = 1,0848$

I will sell $900$ units of Stocks A: $900*32.63 = \$29,367$ and I will buy $1000$ units of Stock B: $1000*30.08 = \$30,080$

The cost of Close the Trade: $ \$29,367 - \$30,080 = -\$713$

To calculate Profit/Loss of this strategy I just sum the The cost of Open the Trade and The cost of Close the Trade which is $\$91$ on this case.

My question is: How can I calculate the $\%$ return of this strategy?

But I've been reading and it got a little confusing for me.

Many thanks!

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