Where is the catch?

...is a question I usually ask myself when something seems to be going 'too well'. Up till now things were looking much too easy, so now seems the right time to start asking questions.
Here is what I did:
1. got a list of 800+ etfs in to Matlab from Yahoo.
2. run a Dickey-Fuller test to establish potential trading pairs. Cointegration was only tested inside a category to avoid pairs with no 'physical' cointegration. Setting a threshold to 3.9 t-static I've got about 900 pairs. Later I've decided to ditch some categories like 'N/A' and 'Bear Market'.
3. Let the 'Duck' strategy loose on the pool pair, let it figure out the optimal sharpe. (I've decided to use animal names for strategy tracking. Of course starting with 'not so cool' animals as rabbits, ducks is logical as early strategies will be not really great. I'll be moving to panthers and tigers in the later stages of develpment). To elaborate more on the Duck, which I'll post later: this strategy tracks the ratio of a pair. Optimization is done on the moving window and z-level threshold. For example: a trade is entered when z-spread is higher than 1.5 and exited when it reverts back to zero. Duck is plain and simple, no fancy stuff like stop-loss or time limits. I've let some big holes in backtesting, like not using training and test sets, not testing the data-snooping to the finest detail etc. But still, this step should give an *indication* on the returns achievable by the pairs. After this step I'll reduce the 900 pair set to a 'profitable' set on which I'll continue my research.

Good, quick and dirty, but let's take a look at the results.


The results provided by Duck are very encouraging: almost all pairs have positive sharpe, but the top of the list alarmed me. Take a closer look at the figure: sharpe ratios of well above 3 a possible even with a dumb duck strategy. Either I'm going to become rich much faster than expected or I haven't thought about something important. I guess the latter.

Ok, let's look at our runner-up, the MZO.

This is where my bad feeling is justified: MZO has zero trading volume for many days! This would result in slippage (I guess) and all other sorts of trouble, like being unable to short the share.
Now, what really confuses me is the fact that liquidity of an etf should be based on the underlying stock as explained here. And MZO has some really heavy weights behind it.

The same goes for many of the promising etf pairs, they seem to miss liquidity.
So now I'm a little confused: is it better to filter out the non-liquid etfs or start building my own share baskets and trading them against each other or bigger sized etfs?