Cointegration-Based Futures Pairs Trading with Spread Bands

Summary

The document introduces stationarity and cointegration as the basis for pairs trading. It describes a stationary series as having a stable mean and variance, and presents a pair as cointegrated when the difference between their prices is stationary. Under that assumption, an unusually wide spread is expected to contract, while an unusually narrow spread is expected to widen, motivating opposing long and short positions in the two contracts.

Its example pairs two related Dalian Commodity Exchange futures contracts and defines the spread as the first contract’s price minus the second’s. It proposes entering short the first and long the second when the spread exceeds its 20-day mean by two standard deviations, with the reverse positions below the corresponding lower band. The example supplies a historical date window, but no results or detailed exit rules. The spread definition assumes a one-to-one price difference; the text does not discuss hedge-ratio estimation, transaction costs, roll handling, or how to test whether cointegration persists.

Key ideas

• The strategy relies on a stationary spread between two related futures contracts.
• It takes opposing long and short positions when the spread moves beyond bands around its 20-day mean.
• The example uses a two-standard-deviation threshold and reverses the positions for a low spread.
• The document notes that cointegration can be temporary but provides no performance results.
• The method does not specify hedge-ratio estimation, trading costs, exits, or contract-roll handling.

Tags

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.