Frac Spread

Investment Summary
The Frac Spread which is the Natural gas / Propane spread is statistically proved to be co integrated. A profitable statistical arbitrage strategy can be executed betting that deviations of the spread from the average spread value will converge back to the mean.

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Investment Performance
Investment Return (?):25.5%Volatility (?):12.5%Sharpe Ratio:1.7Maximum Drawdown:-15.2%
Investment’s Fundamental Concept:
The physical market ensures that the relative mispricing between natural gas and propane can exist only for short horizons and will eventually be corrected due to market forces. Producers and processors will cut production of natural gas and hence the propane supply until profit is restored to the long-term fair value. This fundamental relationship has proved to be statistically cointegrated.
Investment’s Logic:
The financial instruments used to execute the strategy are 2-month futures contracts. The investor uses a 3:1 or 5:2 propane to natural gas spread.

Bollinger bands with a two standard deviation and 15-day look back period is used as a trading indicator. Trading signals are checked daily, and the investor buys the spread when it closes below the lower Bollinger Band and then holds the position for 12 days or till the spread reverses back to the mean. The opposite position is opened when the spread closes above the higher bollinger band.

The research paper provides robustness checks for different Bollinger Band intervals and holding periods and the system is consistenly profitable and robust.

Other Investment Strategy Characteristics:
Investment Type:Statistical ArbitrageInvestment Risk:2/5 LowBacktest Range:30-40 yearsRebalancing period:Daily
Investment Strategy Markets:
  • Propane Futures
  • Natural Gas Futures
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