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# Buy Dax and Sell stoxx: Hedging the two against each other

Discussion in 'Index Futures' started by Shraga18, Oct 8, 2006.

1. ### Shraga18

Hi Everyone,

Having several years of experience in the Sp's and Russell, I've been getting ready to switch to Eurex as it suits my current time-zone better. At first I was thinking of trading the Dax, but after poring over the charts I found myself continually raising the amount of margin I thought I would need to be able to trade the Dax safely. Little scary that one.

Anyway, I started looking at the Stoxx as well, and from looking at many, many charts of the Dax and Stoxx side-by-side, I noticed something interesting: it seemed to me that there was a clear ratio of Stoxx range to Dax range, with this ratio changing as volatility increased. The bigger the move, the bigger the difference in the two. As an example, for a ten point move in the Dax, the Stoxx seemed to move about 70%, or seven points. But when the dax would move 50 points, it would be more like 50%-60%, or 25 to 30 points in the Stoxx. I first set out to see if I could prove these ratios. More on that later, but first, who cares?

Well, let's assume these numbers are just about right. In that case, let's say I sell 3 stoxx for ever Dax long. In the particular methodology I'm looking at, I have tight Dax stops, around ten points, and I look for moves of 50 points and up. That means that a losing trade would costs me approx. \$40 instead of \$250. (10 dax points =\$250, 3*7 Stoxx points=\$210). In case of a winning 50 point trade, assuming a 60% ratio, I would make \$350 (30 stoxx points * 3 = \$900 vs 50 dax points being \$1250). Of course, trading just the dax would make me \$1250.

However! I have now cut my risk by more than half, with the potential loss being 14% of the potential profit, instead of it being over 31% (\$40/\$350 vs \$250/\$1250)!

Let's look at it in another way:

Assume I'm trading ten of these spreads, in the above example I would have profited \$3500, at the risk of losing \$400. In order to reach the same profit with the same amount of points (50) with dax only, I would have to trade 2.8 Dax contracts. But in that case, my potential loss would be \$700 (2.8 * ten dax points)!

Let's take a look at trading only the Stoxx for that matter. In order to reach that profit with 30 stoxx points (which is 60% of the 50p Dax move) I would have to trade 11.66 Stoxx contracts. But that would put my potential risk at \$816 (11.66 * 7 stoxx points), which is more than double!

So basically, what I'm asking those of you here with some experience, doesn't it make sense that if you have a method that has smaller stop losses than your profit targets that you should trade by hedging the Dax and Stoxx against each oher?

Now for some numbers:

I'm still waiting to get the latest Dax and Stoxx data. The last i had till was this past May, so I went back a year from then. In order to prove to myself that the difference in ratio becomes bigger as volatility increases, I wrote a small indicator that would give me the different ratios and wrote them down.

The following are the months, followed by the average percentage of stoxx range vs Dax range for days that had at least a 50 point range in the dax, followed be the percentage for those days that has a dax range smaller than fifty points.

June: 0.610/0.709

July: 0.748/0.728

Aug: 0.592/0.696

Sep: 0.530/0.658

Oct: 0.639 /0.514---1 day only!

Nov: 0.586/0.705

Dec: 0.719/0.640

jan: 0.569/0.718

feb: 0.634/0.706

Mar: 0.616/0.692

April: 0.596/0.695

May: 0.621/0.716

avg: 0.621/681

please note that in October 2005 there was only one day that had a range < 50, so obviously that number is skewed. I didn't do this test to get absolute ratios, merely to prove to myself that on average, the ratio indeed changes according to volatility. On an intraday basis, the Stoxx does seem to have an average 70% ratio to dax for moves around 10-15 points.

I hope some of this made sense, and I hope the experienced Dax/Stoxx traders here will give me some feedback! Also, if someone could forward to me Dax data in Ascii form for the months since May, I could check these past months to confirm the ratios.

All the best,

Shraga

the reason why dax and estoxx move very closely short term, as you have discovered, is that their correlation within high frequencies is strong - i.e. there is no reason why in any given millisecond estoxx should become worth more than dax unless there are significant events.

however, for bigger moves, the correlation weakens, as you have noticed - the problem is that it can go either way.

for example, recall the german elections last year - the dax tanked big initially, a lot more than estoxx - imagine instead those were the french elections with the same initial reaction - estoxx would have plummeted a lot more than the dax - you can see how it would have affected your scenario.

all the best.

3. ### Bitstream

long dax/short cac40 may work well, i see often dax up 1% and cac laggin' waay in the red.

4. ### superfec

am wondering if anyone is familiar with vectorbull.com? it uses algorithms, and seems to do really well with the dax. it also can be used on the dow and the q's, but not as impressively. on the dax, it had 91 winz out of a hundred trades!

well, i've never traded the dax, and frankly, i have never traded futures ...so i am wondering: are there options on the dax? and if so, is the liquidity there for quick in and outz?

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