*This performance is only observed with historical backtests and not traded by the company.
Gasoline and Crude Oil Brent prices are known to have a strong correlation, but what’s not known is that on a month on month basis Gasoline has outperformed Brent between the period of September-December in 8 out of the last 10 years with the average return being 5.6%.
Back test Results for past 10 years based on monthly opening and closing prices
September-December performance (Generic Contract) | |
2010 | 10% |
2011 | 4% |
2012 | 18% |
2013 | 2% |
2014 | 8% |
2015 | 25% |
2016 | 12% |
2017 | -22% |
2018 | 0% |
2019 | -3% |
Sum | 56% |
Average | 5.6% |
Hit ratio | 80.0% |
Besides, since the two instruments have a strong correlation of +80%, when there is a huge deviation in the ratio from the historical average, the pair trade strategy gives an entry signal and when the ratio returns to the average, the strategy gives an exit signal. Back-Tested Results based on the above strategy exhibit a total profit of $176K in the past 10.5 years considering equal exposure of $100K in each instrument. However, it is important to note that Trading pairs is not a risk-free strategy. The difficulty comes when prices of the two securities move contrary to the positions taken resulting in losses. Thus, it is important to adhere to strict risk management rules when dealing with such adverse situations.
Currently, the Gasoline-Brent Pair trade is giving a buy signal (Buy gasoline Sell Brent) expecting the ratio to increase further. The current ratio is 2.79 and the highest in the last 5 years was 4.0853 while the lowest was 1.5235 on a daily closing basis. The low was made in March 2020 when the pandemic created havoc in the financial markets. Technical charts also suggest the ratio is near support levels and could increase from these levels.
Back test Results for past 10 years Gasoline-Brent |
|
Investment | $100,000 |
Exposure to each instrument | $100,000 |
No of Trades | 105 |
P/L in 10.5 years | $176,547 |
Profit % | 177% |
Max Drawdown | -$39,899 |
Hit Ratio | 61% |
Risks & Assumptions
Data Source: Bloomberg
Arun Leslie John
Chief Market Analyst
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