Pairs Trading with Commodities

Quantpedia

Robert Bianchi, Michael Drew

Research

2 Pages

Quantpedia summarizes a commodity pairs trading strategy that exploits temporary price divergences between historically linked futures contracts. Drawing on academic evidence, it argues the approach delivered attractive risk adjusted returns averaging 21.28% annually with a 1.47 Sharpe ratio while remaining largely independent of commodity markets.

Key Takeaways

Strong Risk Adjusted Returns: The strategy produced an indicative annual return of 21.28%, 11.78% estimated volatility, and a 1.47 Sharpe ratio over the 1990 to 2008 backtest.
Systematic Pair Selection: The model forms pairs across 5 commodity groups, trades the top 5 closest pairs, and opens positions when spreads exceed 2 standard deviations.
Diversification Potential: Research finds returns were largely unrelated to traditional commodity market risk factors, suggesting a market neutral approach that can complement broader portfolios.
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