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#205: Statistical Arbitrage—Sort Of

#205: Statistical Arbitrage—Sort Of

micksonmatch
December 20, 2024

S2N Spotlight

The workstation above was my trading desk in 2010. You are probably wondering who cares.

Someone I knew in the hedge fund space said to me, “You should go for a coffee with a young guy, John, who is doing really well; he will like you.” I thought, why not, so I met John, and we hit it off. He said, “Come work from my office. I will set you up for free. I just want to have you around to bounce ideas off from time to time.” So I moved in the next day.

John was doing so well he had bought the whole floor of an office block overlooking Darling Harbour in Sydney. He was still in his 20s and had made close to $20 million trading stat arb with BHP on the London and Australian stock exchanges over a period of around 2 years. I remember his prime broker was Merrill Lynch, and he was using heavy leverage.

John was an engineer who had felt the thrill of trading and was hooked. He had learned the strategy from a friend, and when they had made $20 million in profits, they split it down the middle and went their own way. John bought the office and a few other toys, nothing too lavish, and continued his stat arb trading on BHP and now a couple of other dual-listed companies, but the trades just didn’t seem to make the same kinds of profits they had in the past.

I was amazed how John’s stat arb was built on a somewhat basic Excel spreadsheet with some basic rules. Why am I sharing this?

I am not 100% sure, but I think people who play the MicroStrategy / Bitcoin relationship might be able to make some decent money. I am planting a little seed. I haven’t done the homework, I just think there is something there.

Below I plot the prices of Bitcoin and MicroStrategy over the last year. I probably should have made the chart shorter, as their new treasury scheme of “BTC Yielding” has created a more fixed ratio, which is where statistics can play their part.

If you have a bit of a background in finance, you will be familiar with the term beta, which measures the sensitivity of an asset’s returns relative to the returns of another asset. A beta greater than 1 indicates that the asset is more volatile than the benchmark, while a beta of 1 means it is equally sensitive.

Here is some rough analysis: To play this game, one will need to get involved with intraday data. Just sharing for interest’s sake, there are more than enough traditional statistical arbitrage opportunities. This one is interesting because there is an unusual emotional element to it. That is why the subject line is “Sort of.”

S2N Observations

The FOMC lowered the Fed Funds Rate by 25 bps on Wednesday. They also instructed their dealing desk to offer 4.25% on the reverse repos, which was a 30 bps drop in the rate. This is rare to move the rates to the bottom end of the FOMC’s agreed range. What the Fed is trying to do is grease the system in anticipation of a potential liquidity squeeze. By making the reverse repo rates less attractive, banks are likely to withdraw their excess liquidity from the Fed and lend it out. There is not much left to go with the Reverse Repo balance at $112 billion. Expect this to get to $0 pretty quickly.

There was some strange activity on the Bitcoin blockchain yesterday. Was this a fat-finger mistake or something more suspicious? On the surface it looks like the person input the wrong suggested fee amount and the block miners gladly accepted. The transaction of $13,719.30 cost the sender $789,988 in fees. Ouch!

At a deeper level, there are things called “dusting” and “burning,” which can be ways for people to disguise and anonymize transactions. This is above my pay grade. Fun fact: the cost of a transaction on the network is dictated by the size of the block in bytes, not in value.