HedgeFundLiveTrading Report Feb21 Page 2 of 4
As mentioned in the previous report, one of our strategies going forward was experimenting with pairstrading. There were two types of pairs under consideration: 1. Pair a company with its ETF sector. Hedge against events of individual companies by pairing it with arespective ETF.2. Find two sectors that would hedge each other-i.e. two sector ETFs. First, we used our industry knowledge to gage potential companies or sectors that may have a reason tooutperform or underperform their ETF or work as a hedge to another sector. Concerning the hedgingside, this proved to be fairly difficult because as a whole, the health care sectors were trending up withlittle presence of natural hedges. This meant that there seemed to be continued confidence in thehealthcare sector as a whole rather than if this sector was performing well, a corresponding sector wouldnot. However, the only sector that showed negative growth over the past 3 months was pharma but it wasdifficult to identify what pharma could potentially act as a hedge to on a sector basis. Due to this recentnegative growth in pharma though, we decided to go beyond sectors and into companies and hencelearning more to option #1 rather than #2 for the time being. To this end, we began looking atpharmaceutical companies and their respective ETFs. Part of this strategy would be to look at historicaldata of selected companies and compare them to their sector ETF to see how they correlated especiallygiven a history of company events and if there would be a potential pair. We took a look at a quintessential pharma company, Pfizer, because of a long active history of events ofdrug approvals and drug failures on which to compare the effect on its stock price and its correlation tothe ETF pharma sector. We also took a look at BristolMyers Squibb because it is a company that willhave an FDA ruling on a new drug soon. Below we will explain our methodology and some of thelimitations to this approach of trading.
Discussion on event-based trading strategy
As the next step, we try to gain exposure to single health care companies where we take bets on eventoutcomes. To validate this idea, we did the following analysis on key assumptions.
Analysis on Events-Price-Spread relationship
For such a strategy to work, the following assumptions need to be true:1. There are enough key events/news for us to bet on, for example drug approvals.2. We can predict some of the event outcomes based on our health care knowledge.3. The market interpretation of these event outcomes drives underlying stock price changes.4. We can predict the direction of underlying stock price changes by interpreting how the marketviews particular event outcomes. To validate this event-based trading strategy, we chose to dig into historical data for Pfizer and BMS inthe past 20 months to examine assumption #3 and #4.