what the vol spread chart hides

Friends,

People will message me with charts like this to ask my opinion of a pairs trade:

This is not a pair anyone sent me but the form is the same.

I guess-and-tested a few pairs whose daily return correlation is at least as high as some pairs I’ve been sent. In this case, I picked 2 homebuilders whose correlation over the last 500 calendar days turned out to be .90

[I used the hedge ratio tool from last Thursday to find this pair]

I respond to these messages with a few things that come to mind but I’ll flesh the responses out more in this post. Think of it as a map of data and interpretation pitfalls. There are bits in here for both novices and pros that’ll stimulate a “I never thought of that before”.

The charts above aren’t worthless but they’re very faint beeps on a metal detector during a beach stroll.

Let’s see why…