Developing and Trading Strategies Indices

Strategy Indices are indices that track the performance of an algorithmic trading strategy. The algorithm clearly and transparently specifies all the actions that need to be taken. The following are examples of algorithms that strategies can be based on.

1) Pairs Trading Strategy. This strategy examines pairs of instruments that are known to be statistically correlated. For example, consider Shell and Exxon. Both are oil stocks and are likely to move together. Knowledge of this trend creates an opportunity for profit, as on the occasions when these stocks break correlation for an instant, the trader may buy one and sell the other at a premium.

2) Fed Funds Curve Strategy This strategy takes a view on the shape of the curve based on the actions of the Fed. In this strategy, one puts on a steepener or flattener, based on whether the Federal Reserve has cut the benchmark rate or raised it. This is based on the conventional wisdom that the curve steepens when the rate is expected to be cut and vice versa.

3) Implied Volatility against Realized Volatility In a number of markets such as commodities and rates, the implied volatility, as implied by straddle prices is higher than the realized volatility of the underlying forward. One way to 'exploit' this is to sell a short expiry straddle on day 1 and delta-hedge the straddle every day. The strategy makes money if at expiry, the premium received, the final value of the straddle and the final value of the forwards is greater than zero.