tothe US Nasdaq 100 index.
42
Intermarket Trading Strategies
• The SDAX (small cap) which consists of 50 shares from the classic sector that rankdirectly below the MDAX in terms of market capitalization and trading volume.The SDAX is equivalent to the US Russell 2000 index.• The HDAX, which is a large cap index and includes the 110 largest German equitiesfrom all sectors of the economy. This is equivalent to the US Russell 1000 index.• The L-DAX (symbol: GDAXIL) is a late index, indicating the price developmentof DAX 30 index’s performance after the Xetra electronic-trading system closesand is based on the floor trading at the Frankfurt Stock Exchange. The L-DAXindex is computed daily between 17:30 and 20:00 CET and takes over after theDAX closes at 17:30 hours CET.• The Dax Volatility Indices: VDAX (symbol: VDAX) and VDAX-NEW (symbol:V1X). These are the German equivalents to the CBOE volatility index (VIX) andtrack the implied volatility of the DAX index. In simpler terms the volatility indicesmeasure in percentage terms whether the DAX options are selling above or belowtheir fair values (as generally estimated by the Black-Scholes formula).The calculation of the new V1X index is based on DAX option contracts, whichare quoted both “at the money” and “out of the money”. Thus, VDAX-NEW has abroader volatility surface than the VDAX, which only takes into account optionsthat are “at the money”. The VDAX-NEW will replace VDAX in the medium-term.Each September the Deutsche Börse decides whether changes are to be made to thecomposition of the index. More information about German indices can be found atthe Deutsche Börse’s website at http://boerse-frankfurt.com.The DAX is a highly cyclical index that now (May 2008) faces a potential downturnas fully one-fifth of the index is made up of financial stocks, which are sinking tomulti-year lows.Futures and options on the DAX trade in the Eurex Exchange (symbol: FDAX)from 8:00–22:10 CET; they have a contract value of 25 euro per index point of theDAX index and are highly liquid with an average volume of more than 200 000contracts per day.
4.2
THE CAC 40
The CAC 40 index (symbol: FCHI), which takes its name from the Paris Bourse’s earlyautomation system “Cotation Assistée en Continu” (Continuous Assisted Quotation),is the main benchmark of the Euronext Paris. Tracking a sample of blue chip stocks,its performance is closely correlated to that of the market as a whole. The indexcontains 40 stocks selected from among the top 100 by market capitalization and themost active stocks listed on Euronext Paris, and it is the underlying asset for optionsand futures contracts. The base value was 1000 on 31 December 1987 and historicaldata are not available prior to that date.
International Indices and Commodities
43
The CAC 40 is a market value-weighted index. Since 1 December 2003, this indexis no longer weighted by the total market capitalization of the component stocksbut by their free float adjusted market capitalization. This method of calculation,already used for other major indices around the world, ensures greater coherencebetween the real allocation of companies on the market and how it is expressed inthe indices. It also limits the manifestation of volatility caused by too much of animbalance between the weight of a stock in the index and the corresponding free floator available shares in the market. The index composition is reviewed quarterly byan independent Index Steering Committee and a capping factor is used to limit anindividual stock weight to 15 %.CAC 40 futures trade under the symbol FCE at the Euronext (MONEP) and theyhave a contract value of 10 euro per index point.MONEP handles equity options, long- and short-term options, and index futures.Futures are liquid for trading purposes. An average of 120 000 contracts per daychanged hands for the earliest expiring contract.Listed below are the top 10 companies currently (as of 31 December 2007) contained within the index and below that a breakdown by industry group:CAC 40 top 10 Constituents
12345678910
Total – Oil & Gas12.6 %Sanofi-Aventis – Pharmaceuticals6.7 %BNP Paribas – Banking6.2 %Suez – Utilities5.6 %France Telecom – Telecommunications 4.7 %Axa – Insurance4.5 %ArcelorMittal – Steel4.5 %Société Générale – Banking4.3 %Vivendi – Entertainment3.6 %Carrefour – Retail3.6 %
CAC 40 breakdown by industry
12345678910
FinancialsIndustrialsConsumer GoodsOil & GasUtilitiesConsumer ServicesHealth CareBasic MaterialsTelecommunicationsTechnology
19.2 %12.6 %12.6 %12.5 %11.9 %9.6 %7.6 %6.7 %5.2 %2.1 %
44
Intermarket Trading Strategies
Financials at 19.2 % are the most heavily weighted group followed by Industrials andConsumer Goods (which includes famous French luxury goods manufacturer LouisVuitton, Moet Hennessy (LVMH) and beauty products producer L’Oréal).4.3
THE FTSE
The FTSE 100 index (pronounced “footsie”) is a share index of the 100 largestcompanies listed on the London Stock Exchange, weighted by market capitalization.The index calculation began on 3 January 1984 and historical data are not availableprior to that date. Component companies must meet a number of requirements set outby the FTSE Group, including having a full listing on the London Stock Exchangeand meeting certain tests on free float and liquidity. The constituents of the FTSE100 are reviewed and changed four times a year.Trading lasts from 08:00–16:29 (when the closing auction starts), and closingvalues are taken at 16:35. The highest value of the index to date was 6950.6, set on30 December 1999 at the height of the internet bubble.Though it only contains the top 100 companies, the FTSE correlates closely withthe All Share Index and, indeed, some broad US stock market indices.Listed below are the top 10 companies currently (31 August 2007) contained withinthe index and below that a breakdown by industry group:FTSE 100 top 10 constituents
12345678910
BP Plc – OilHSBC Holdings – BankingVodafone Group – TelecommunicationsGlaxosmithkline – PharmaceuticalsRoyal Dutch Shell Plc – A Shares – OilRoyal Bank Of Scotland – BankingRoyal Dutch Shell Plc – B Shares – OilBarclays – BankingAnglo American – MiningAstrazeneca – PharmaceuticalsFTSE 100 breakdown by industry
12345678910
FinancialsOil & GasConsumer ServicesConsumer GoodsBasic MaterialsHeath CareTelecommunicationsUtilitiesIndustrialsTechnology
27.7 %17.2 %10.5 %10.3 %10.1 %8.2 %7.6 %4.7 %3.5 %0.2 %
7.1 %7.0 %5.6 %4.9 %4.7 %3.6 %3.6 %2.7 %2.6 %2.5 %
International Indices and Commodities
45
With oil and gas stocks making up almost 17 % of the index at the moment, the FTSEis very sensitive to oil prices. However, financials at 27.6 % are the most heavilyweighted group and the reason for the precipitous decline during the sub-prime crisisin 2007–2008, despite rising oil prices.The FTSE 100 index reached a 5-year high on 13 July 2007; this was partly causedby the increase in the price of oil and the resultant increase in the share prices of BPand Shell.The index is seen as a barometer of success of the British economy and is a leadingshare index in Europe. It is maintained by the FTSE Group, a now independentcompany which originated as a joint venture between the Financial Times and theLondon Stock Exchange (hence the abbreviation Financial Times Stock Exchange).According to the FTSE Group’s website, the FTSE 100 companies represent about81 % of the UK share market.FTSE futures trade at the London International Futures & Options Exchange(LIFFE) from 8:00–21:00 GMT (9:00–22:00 CET) under the symbol Z.
4.4
THE DOW JONES STOXX 50 AND EURO STOXX 50
The Stoxx 50 (STXX50) tracks the performance of the 50 most important andmost actively traded shares in the pan-European area, while the Euro Stoxx 50(STOXX50E or ESTX50) tracks the 50 most important stocks in the Eurozone. TheEuro Stoxx covers 50 stocks from 12 Eurozone countries: Austria, Belgium, Finland,France, Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, Portugal andSpain.The criteria for including a company in the index are market capitalization andtrading volume of the European companies. Both indices are market capitalizationweighted.Futures for both are highly liquid and trade at the Eurex (DTB) from 8:00–22:10CET under the symbols FSTX and FESX respectively.The Dow Jones Euro Stoxx 50 (Price) was developed with a base value of 1000 asof 31 December 1991 and uses float shares.
4.5
THE NIKKEI
The Nikkei 225 (N225) is Japan’s most widely watched index of stock market activityin the Tokyo Stock Exchange (TSE) and has been calculated continuously since7 September 1950 by the Nihon Keizai Shimbun (Nikkei) newspaper. It is a priceweighted average (the unit is yen), and the components are reviewed once a year.The Nikkei Stock Average is the average price of 225 stocks traded on the firstsection of the Tokyo Stock Exchange, but it is different from a simple average in thatthe divisor is adjusted to maintain continuity and reduce the effect of external factorsnot directly related to the market.
46
Intermarket Trading Strategies
The Nikkei average hit its all-time high on 29 December 1989 when it reached anintra-day high of 38 957 before closing at 38 916. Thirteen years later, the Nikkei hadplunged more than 80 % from its 1989 highs.The Nikkei’s devastating decline was triggered by a real estate crisis similar to theone experienced in the United States in 2007–08. At the height of the Japanese marketin 1989, Japanese banks were lending money secured by real estate. Investors tookthe borrowed money and ploughed it into the stock market. A snowball effect beganwhen the real estate market crashed, pressuring further property and stock prices.The Nikkei finally made a bottom on 28 April 2003 at 7608.On 12 August 2005 it broke out from a 20-month rectangle formation and on26 February 2007 rose to a six-year high of 18 215.Nikkei futures trade in Osaka (symbol: N225), in the Chicago Mercantile Exchange(CME) in US dollars (symbol: NKD), in yen (symbol: NIY) and in Singapore (symbol:SGXNK). The Osaka exchange has recently introduced the Nikkei 225 mini contract(symbol: N225M).
4.6
THE HANG SENG
The Hang Seng (HSI) is a barometer of the Hong Kong stock market and includescompanies from Finance, Utilities, Properties and Commerce, and Industry subindexes. The index calculation began on 24 November 1969 and Hang Seng Indexfutures (symbol: HSI) were introduced by the Hong Kong Futures Exchange in 1986.Only companies with a primary listing on the Main Board of the Stock Exchangeof Hong Kong (SEHK) are eligible as constituents. Mainland enterprises that have anH-share listing in Hong Kong will be eligible for inclusion in the Hang Seng Index(HSI) only when the H-share company has 100 % of its ordinary share capital listedon the Hong Kong Stock Exchange.Hang Seng futures trade in Hong Kong (symbol: HSI) from 9:45–12:30 (firsttrading session) and 14:30–16:30 Hong Kong time (second trading session). Themultiplier is HK$50 per index point. Mini contracts are also available with a multiplierof HK$10 per index point.
4.7
TRADING HOURS, SYMBOLS AND VOLATILITY
In Table 4.1 you can find European and US trading hours of the major exchanges.You can see that trading in some Asian markets is not very convenient for Europeantraders as they open too late at night and close too early in the morning.You can find current quotes and historical prices for most of the internationalindices in Yahoo Finance http://finance.yahoo.com which is free for 20-minute delayed quotes. I thought it would be useful to include a list of symbols used by themost popular data providers or brokers for some international indices in Table 4.2
International Indices and Commodities
47
Table 4.1 Trading hours in local, US Eastern time (EST) and Central European time (CET)for major world exchanges. All the times shown are standard winter times. Please note thatJapan and China do not currently observe the daylight saving time (DST) or summer time andconsequently the CET and EST opening and closing time indicated should be moved forwardby one hour. The transition to summer time starts on 25 March and ends on 28 October inEurope. In the United States the transition starts two weeks earlier, on 11 March and ends on4 November.Time
Country
Exchange
LocalOpen
LocalClose
ETOpen
ETClose
CETOpen
CETClose
USACanadaGermanyGermanyFranceBritainJapanHong KongAustralia
NYSE, NasdaqTorontoXETRAFrankfurtParisLSETokyoHong KongASX
9:309:309:009:009:007:009:0010:0010:00
16:0016:0017:3020:0017:3015:3015:0016:0016:00
9:309:303:003:003:002:0019:0021:0018:00
16:0016:0011:3014:0011:3010:301:003:000:00
15:3015:309:009:009:008:001:003:000:00
22:0022:0017:3020:0017:3016:307:009:006:00
as each one uses a different symbol for the same index. You will notice that USbrokers are still of the old fashioned mentality that foreign markets are irrelevant toUS investors and do not provide any data for non-US indices. Of course US marketsdo not exist in a vacuum and it would be very helpful for US investors to checkhow the international markets are doing before the US market opens for trading.International indices would be also useful for traders of international ETFs or ADRsthat are trading in the US exchanges.I thought it would be useful for international traders to include the most likely dailypercentage changes for some of the major international indices and commodities inorder to assess risk adjusted positions in each market accordingly (see Table 4.3).Each value in Table 4.3 indicates the daily change that was exceeded by the percentilein the top row. For example the S&P 500 was up by more than 1.57 % only 5 % ofthe time. Frequency distribution values are included instead of standard deviationsbecause, as discussed in Chapter 2, none of the indices conform to the normalityassumption.An interesting comparison between actual observations and theoretical probabilities as predicted by the normal distribution is depicted in Table 4.4. It can be seen thatthere is an exponential shift from the middle to the tails of the distribution makingpredictions beyond the 0.02 level of significance totally unreliable.Since 6 July 2007 the Securities and Exchange Commission (SEC) have abolishedthe “uptick rule”, a regulation that prohibited short selling following downticks. This
48
Intermarket Trading Strategies
Table 4.2 Symbols for the major world indices used by different data providers andbrokers. They usually differ from provider to provider by a prefix or a suffix. Blank cellsindicate that the index was not available at that broker or data provider.IndexnameS&P 500S&P 100Dow JonesIndustrialsDow JonesTransportsNasdaq 100NasdaqCompositeRussell 2000NYSECompositeCanada TSXDAXCAC 40DJ Euro Stoxx50DJ Stoxx 50FTSE 100Greece GeneralNikkei 225Hang SengKorea KOSPIAustralia AllOrdinariesBrazilBOVESPAMexico IPC10 Yr TreasuryYieldAmex OilIndexCRB IndexEuroDollar IndexGoldVolatility IndexCrude OilSilverPHLXGold/Silver
Reuters
YahooFinance
TC200
CSIData
E* Trade/Schwab
InteractiveBrokers
.SPX.OEX.DJI
ˆSPXˆOEXˆDJI
SP-500OEXDJ-30
SPX-IOEX-IDJIA-I
$SPX$OEX$DJI
SPXOEXINDU
.DJT
ˆDJT
DJ-20
DJAT-T
$DJT
TRAN
.NDX.IXIC
ˆNDXˆIXIC
NDX–XCOMPQX
NDX-ICOMP-I
$NDX$COMPX
NDXCOMP
.RUT.NYA
ˆRUTˆNYA
RUT-XNYSE
RUT-INYA-I
$RUT$NYA
RUTNYA
.GSPTSE.GDAXI.FCHI.STOXX50E
ˆGSPTSEˆGDAXIˆFCHIˆSTOXX50E
TSX–XFDAC-XPCAC-X–
TCMP-IGDAX-FFCHI-I
.STOXX50.FTSE.ATG.N225.HSI.KS11.AORD
ˆSTOXX50ˆFTSE–ˆN225ˆHSIˆKS11ˆAORD
–FTSE-X–NIKI-XHKHS-X––
.BVSP
ˆBVSP
.MXX.TNX
––––
TSXDAXCAC40ESTX50
FTSE-FATG-FN225-FHSI-FKS11-FAORD-F
–––––––
STXZ–N225HSI––
–
BVSP-F
–
–
ˆMXXˆTNX
–TNX–X
MXX-FTNX-I
–$TNX
TNX
.XOI
ˆXOI
XOI
XOI-I
$XOI
XOI
.CRBRD-EUR=.DXYXAU=.VIX–XAG=.XAU
–EURUSD=XNAXAUUSD=XˆVIXNAXAGUSD=XˆXAU
CRY0–DXY0XGLDVIX–XXOILXSLVXAU
@CR––MAU0VIX-I––XAU-I
––––$VIX––$XAU
–EUR.USD––VIXCL–XAU
–
International Indices and Commodities
49
Table 4.3 Frequency distribution of daily yields of major stock market indices andcommodities from 1992 to 2006. The daily changes are divided by percentiles according tovalues below which certain percentages of cases fall. So, for example, the 5 % percentile ofthe S&P 500 daily change is −1.59 % which means that the S&P 500 declined by −1.59 % orless only 5 % of the time.PercentilesDaily Change %S&PDJ-30Russell 2000NDXTSXEuro StoxxDAXCACFTSEATGNikkeiHang Seng10 Yr Tr Note YieldXOIOILCanada VentureXAUSilverGoldCRBDollar IndexEuroYenCornWheat
5
10
25
50
25
10
5
−1.59−1.52−1.84−3.10−1.34−2.40−2.26−2.12−1.60−2.35−2.34−2.43−1.75−1.99−3.48−1.50−3.47−2.46−1.34−1.06−0.86−1.02−1.07−2.23−2.49
−1.08−1.06−1.33−2.18−0.92−1.68−1.58−1.47−1.15−1.59−1.72−1.66−1.34−1.35−2.50−1.02−2.66−1.66−0.89−0.75−0.65−0.74−0.77−1.76−1.95
−0.46−0.47−0.50−0.90−0.39−0.76−0.65−0.68−0.51−0.72−0.80−0.70−0.68−0.63−1.15−0.39−1.41−0.71−0.38−0.37−0.31−0.37−0.37−0.90−1.13
0.040.050.110.120.060.050.080.020.020.020.000.040.000.050.060.14−0.070.000.000.020.010.000.000.00−0.07
0.550.570.601.030.520.820.780.770.570.800.790.830.600.761.280.681.400.820.430.390.310.370.390.841.09
1.131.131.252.170.991.691.581.521.151.801.691.791.351.502.561.182.901.810.990.760.640.790.801.842.22
1.571.561.783.061.322.362.222.101.622.552.272.471.932.013.451.583.942.481.381.090.861.071.062.582.85
rule was created after the 1929 stock market crash in order to prevent short-sellersfrom adding to the downward momentum of a sharp decline by requiring every shortsale to be executed on a higher price than a previous trade. This rule has been ineffect for 78 years. But can the recent volatility in the markets be blamed entirely onthe rescinding of the uptick rule?At the time of writing, not enough data were available for such a study as therecent volatility has been exaggerated by the combination of the housing and relatedfinancial upheavals. It would be interesting to see the effect that this rule had on theprobabilities of daily changes of the S&P 500 (in Table 4.4).
Symbol
SPXESDDYMNDXNQER2NKDJNIFDAXFCEFESX6EZGYGZNGBLCLQMZWZC
Name
S&P 500S&P 500 miniDJ-30DJ-30 miniNasdaq 100Nasdaq 100 miniRussell 2000 miniNikkeiNikkeiDAXCAC 40Euro Stoxx 50EuroGoldGold mini10 Year Note10 Year BundCrude OilCrude Oil miniWheatCorn
250502551002010051000251010125 00010033.210001000100050050005000
Multiplier12.212.410410625.225.311.120421471.559.346.00.017.27.20.50.51.71.80.10.1
−1.1−1.2−1.1−1.1−1.9−1.9−1.6−1.6−1.6−1.7−1.5−1.6−0.7−1.2−1.2−0.5−0.4−2.6−2.6−2.1−1.81.11.11.11.11.81.81.61.71.71.71.41.50.81.31.30.50.42.82.82.31.9
ATR
Max % daily change10th percentile15161633214535148724710
For equalprofit/loss151616222134326862445
Volat.adjusted
Contracts to trade
49 000929 000732391 8907600314 00016 000750083 000152 635146 530863 522171 00044 0005200919 0001 115 000430 00030 00057 000204 000
Averagevolume
Table 4.5 Contracts to trade based on either equal profit/loss or historical volatility. The fourth and fifth columns are daily % changesexceeded only 10 % of the time during a 5-year observation period. The sixth column is the Wilder’s average daily true range, the seventhand eighth columns are the suggested number of contracts to trade for equal profit/loss based on the expected historical 10th percentile ofdaily changes or based on the historical volatility respectively. The last column is the 50-day average volume as of April 2007.
50
Intermarket Trading Strategies
Table 4.4 Probabilities of S&P daily declines as predicted by the normaldistribution vs. frequency distribution of observed actual values on 15-year datafrom 1992 to 2006.S&P 500 daily % change−5.10 %−3.08 %−2.60 %−2.22 %−1.90 %−1.75 %−1.59 %−1.08 %−0.46 %0.04 %
4.8
Actual probability
Normal probability
0.1 %0.5 %1.0 %2.0 %3.0 %4.0 %5.0 %10.0 %25.0 %50.0 %
0.000 %0.091 %0.418 %1.200 %2.636 %3.695 %5.219 %13.253 %30.983 %50.225 %
THE DOLLAR INDEX
Just as the S&P 500 provides a general indication of the value of the US stock market,the US dollar index (symbol: DXY) provides a general indication of the internationalvalue of the US dollar and it is a measure of the value of the dollar relative to itsmost significant trading partners. Similar in many respects to the Federal ReserveBoard’s trade-weighted index, the dollar index does this by averaging the exchangerates between the US dollar and six major world currencies.The dollar index is calculated by taking the geometric weighted average of thedollar’s value against a basket of six major world currencies and is calculated bytaking the product of each currency spot rate raised to the corresponding weightaccording to the following formula:USDXY = 50.14348112 × EURO−0.576 × YEN−0.136 × GBP−0.119× CAD−0.091 × SEK−0.042 × CHF−0.036
(4.1)
In the formula above all currencies are expressed in USD per unit of the foreigncurrency.To express the yen, Canadian dollar, Swedish krona and Swiss franc in their morefamiliar format in yen per US dollar, CAD per US dollar, SEK per US dollar andCHF per US dollar you only need to change the sign of the weight exponent. Theabove formula (4.1) then becomes:USDXY = 50.14348112 × EURO−0.576 × USDJPY0.136 × GBP−0.119× USDCAD0.091 × USDSEK0.042 × USDCHF0.036(4.2)
52
Intermarket Trading Strategies
Table 4.6 Suggested number of shares to trade based on either equal profit/loss or historicalvolatility. The number of shares to trade for equal profit/loss is based on the expectedhistorical 10th percentile of daily changes during the last 5-year period (at the time ofwriting) and the volatility adjusted quantity is based on the yearly historical volatility.Shares to trade
Symbol
UnderlyingIndex/Commodity
For equalprofit/loss
Volatilityadjusted
Averagevolume
SPYDIAQQQQIWMEWJEWGEWQEZUFXEGL