I've made some progress designing a market neutral strategy. My test set is XLE (stocks and its component stocks (2001-2009). The strategy trades each stock against the XLE using bollinger bands. A trade is entered when the spread between XLE and a stock exceedes 2. A position is closed after the spread crosses zero. As a safety measure, a stop-loss at 5% is implemented together with a maximum holding period of 60 days. Transaction costs are 0.2% one-way.
Generally I get sharpe ratios around 0.8 without optimization ( z-score and window size are fixed).
Now I'm unsure how far can I push the simple stock-index arbitrage. If I start optimizing for a specific stock, overfitting seems to occur very fast.
I still see some possible improvements to the strategy, but I'm not sure if I'll be able to push it above 1. There should be a limit how much profit you can squeeze from stock-etf arbitrage anyway.
The question I'm asking myself now 'is this good enough?'. Apart from a personal preference about risk I'm very curious about the results achieved by others.
Which Sharpe ratio is 'good enough' for stock-index arbitrage in your opinion?