Pairs Trading - Coca-Cola (KO) & PepsiCo (PEP)
Pair Trading Strategy
This is a market-neutral, mean-reversion strategy using Coca-Cola and PepsiCo. I plan to trade based on deviations from historical correlation, entering positions when the Z-score of their log price spread becomes extreme.
Outline
- Track the log price spread between KO and PEP
- Calculate Z-score of the spread
- Enter trades when Z > 2 or Z < -2
- Exit when Z-score returns to 0
- Stop-loss if Z exceeds ±3 or after 5 days (max holding period)
Trading Plan
Entry Signal
- Compute the Z-score of the log-price spread between KO and PEP.
- If
Z > 2, short KO and long PEP. - If
Z < -2, long KO and short PEP.
Exit Signal
- Exit the trade when Z-score crosses back to 0.
- OR exit if a stop loss is triggered at
Z > ±3. - Max hold time: 5 trading days
Position Sizing
- Dollar neutral: invest equal dollar amounts on both sides.
Sample Trade
| Date | KO Price | PEP Price | Action |
|---|---|---|---|
| Mar 8, 2025 | $62.00 | $167.00 | Short KO, Long PEP |
| Mar 12, 2025 | $60.80 | $168.50 | Close position |
| Return | -1.94% | +0.90% | Net: +1.2% |