Tuesday, October 30, 2007

China Pairs Redux

Recognizing that my last post was somewhat controversial based on seekingalpha.com commentary, here is a follow up article reporting how the hypothetical China Rebalancing Pairs Trade would have performed through yesterday's close: a) since posted on the morning of October 11th; and, b) since the FXI's short-term moving average first reversed.

a) Since Posted (10/11)-

> Short CAF/ Long EWH +14.9%
> Short FXI/ Long EWH -00.1%

b) Since First FXI 3-Day MA Reversal (10/22)-

> Short CAF/ Long EWH +8.0%
> Short FXI/ Long EWH +5.4%

These results assume equal dollar weightings and no commissions. A proposed change by the Chinese government to allow share classes to float together no doubt helped significantly. A few "comments on the comments":

1) Note how the use of the long/short combination reduced the risk of "being early" with this trade idea (FXI is actually higher since the 11th).

2) It is true that the CAF is a closed-end ETF trading below its NAV. It has been my observation; however, that such NAV mispricings often persist and shouldn't necessarily preempt a short-term trade backed by a well thought out rational.

3) Whether or not you agreed with the original rational, a good long/short pairing exhibits a highly correlated, mean reverting return series (i.e. cointegrated). This pairing fit the bill and paid handsomely.

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