Monday, September 08, 2008

Index change strategy

Some years ago, I traded a simple index change strategy: buying stocks to be added to the SP500 index at the market open right after the index change announcement and exiting the position at the close, and similarly shorting stocks to be deleted. The results were mediocre at best.

However, new research by University of Edinburgh Business School suggests that a similar strategy works well for FTSE350 stocks (Hat tip to J. Rigg for the link). The trick is to predict which stocks are to be added or deleted 30 days before the announcement ("review date"), buy/sell the stocks, and close out the positions just before the review date.

Since the criteria for inclusion in the FTSE index is well-defined (and primarily based on market capitalization), it should not be hard for the interested traders to make their own predictions and profit from this rebalancing.

6 comments:

Highgamma said...

Don't do it! Chasing index recomposition is a trap! Save yourself! (Oh, the memories of BP Amoco still haunt me these many years later....)

Highgamma said...

I meant BP Arco. Sorry.

Max Dama said...

Hey Ernie,

How are you doing? I'm always interested to hear your thoughts.

Regards,
Max

Ernie Chan said...

Hi Max,
Just as in January 2008, this financial crisis has been excellent profit opportunities for mean-reversal strategies. (See http://epchan.blogspot.com/2008/01/are-quant-strategies-in-trouble-yet.html). Again, momentum strategies were slaughtered this week.

Ernie

Max Dama said...

Ernie,

Are you going to visit San Francisco to publicize your book? The publisher is taking quite a while to release it although I see that it now has a cover. I'm not sure how it works but is there a channel to get a pre-release copy?

I was a little surprised there was no drop before the close today since anything could happen over the weekend. I'm 19 so this is basically new to me.

Regards,
Max

Ernie Chan said...

Hi Max,
The book is on schedule to be published in November. Unfortunately at this stage no preview version is available. I will leave it to the publisher to see if any promotion in person is necessary!

The news of the massive bailout was confirmed by the Treasury before the end of the day, hence we should expect the trend to continue throughout the day. Mean-reversion typically happens in the absence of confirmation.

Ernie