Question

You discover a technical ‘anomaly’ in the US stock market. You find that stocks that go up X% or more 2 days in a row have an expected alpha of X/100% the following day (for example if a stock goes up 6% and 9%, then the next day its expected alpha is 0.06%). Suppose stock A has a BID-ASK spread of 0.2%, and has gone up 10% and 15% percent in the last 2 days. What is your expected profit (in dollars) if you choose to implement your strategy and take a $1000 position in the stock for one day?

Answer 1

expected profit = -$ 1 ( this means that you incurred a loss )

Step-by-step explanation:

Given that the alpha is calculated as : X / 100%

And

stock A has a spread of = 0.2% and has gone up by 10% and 15%

The alpha = 10 / 100% = 0.10%

Hence when you take a $1000 position the profit = 1000 * (0.001 - 0.002 )

= 1000 * (-0.001 ) = -$1