INTERMARKET ANALYSIS REDUX John J. Murphy, considered the father of intermarket analysis, analyzed the period around the stock market crash of October 19, 1987 and showed how intermarket analysis warned of impending disaster months before the crash. He showed how T-Bonds began to collapse in April 1987, while stocks rallied until late August 1987. The collapse in the T-Bond market was a warning that the S&P500 was an accident waiting to happen. Normally, the S&P500 and T-Bond prices are positively correlated. Many institutions use the yield on the 30-year Treasury and the earnings per share on the S&P500 to estimate a fair trading value for the S&P500. This value is used for their asset allocation models. T-Bond yields are very strongly correlated to inflation. Historically, they are about 3 percent, on average, over the Consumer Price Index (CPI). Movements in the Commodity Research Bureau (CRB) listings are normally reflected in the CPI within a few months. In 1987, the CRB had a bullish breakout, which was linked to the collapse in the T-Bond market. The CRB, a basket of 21 commodities, is normally negatively correlated to T-Bonds. Eurodollars, a measure of short-term interest rates, on the other hand, are positively correlated to T-Bonds and usually will lead T-Bonds at turning points. A breakdown in Eurodollars usually precede a breakdown in T-Bonds. Then there's gold. The gold market began to accelerate to the upside just as Eurodollars began to collapse. Gold anticipates inflation and is usually negatively correlated with interest-rate-based market rates such as the Eurodollar. Copper is also inversely correlated to T-Bonds. When copper bottoms, look for the T-Bond to top. The copper/T-Bond relationship is very stable and reliable. In fact, copper is a more reliable measure of economic activity than the CRB index. Many other markets have an effect on T-Bonds. One of the most important markets is the lumber market. Lumber is another measure of the strength of the economy and is predictive of T-Bonds. Lumber and T-Bonds have an inverse relationship. Crude oil prices, another measure of inflation, are inversely correlated to both T-Bonds and the Dollar index. Dollar, is normally negatively correlated with the CRB and gold. Conversely, T-Bonds and foreign currencies are positively correlated. On a longer-term basis, this relationship makes sense. When interest rates drop, Dollar-based assets become less attractive to investors and speculators. Foreign currencies gain a competitive edge, and the Dollar begins to weaken.
Commodity Suppliers & Seasonality Various commodity contract prices rise and fall with the seasons of the year. The movements appear to flow in what seems to be a predictable rhythm, prices seem to always go up at certain times of the year and down at other times of the year. Whether it is spring planting season for agricultural commodities, a summer vacation low for equities, or December demand for precious metals, there always seems to be something on the calendar that influences supply and demand in the market. As you think about commodity producers, especially those that produce agricultural commodities, it is important to remember which hemisphere they are in because that will have an influence on crop cycles. When it is summer in the Northern Hemisphere, it is winter in the Southern Hemisphere, and vice versa. Northern Hemisphere: Is the half of earth that is north of the equator which is around 90% of the earth's total human population. Southern Hemisphere: Is the half of earth that is south of the equator which is around 10% of the earth's total human population. Energy Crude Oil - The top three global producers of crude oil are as follows: Russia Saudi Arabia United States Natural Gas - The top three global producers of natural gas are as follows: Russia United States Iran April, May & June: Crude oil prices typically begin to increase in the spring as gasoline producers begin to anticipate the well-known summer driving season in the United States. July, August & September: Crude oil prices typically jump the most during the summer season as the amount of drivers on the road increase during the summer and producers of winter heating oil are increasing their supplies to sell at the start of the autumn. October, November & December: Crude oil prices typically decrease the most during the autumn months as people begin to drive less. Also, people tend to buy most of their heating oil at the beginning of the season leaving less demand during the rest of the season. Precious metals Gold - The top three global producers of gold are as follows: China Australia Russia Silver - The top three global producers of silver are as follows: Mexico China Peru Agriculture Soybeans - The top three global producers of soybeans are as follows: United States Brazil Argentina April, May & June: Spring in the Northern Hemisphere is planting time for soybeans. The soybean planting season has a direct impact on supply in the market. If it is a productive planting season, supply will increase, which should decrease the price of soybeans. If it is a poor planting season, supply will decrease, which should increase the price of soybeans. Spring in the Southern Hemisphere is harvest time for soybeans. The soybean harvest has a direct impact on supply in the market. If it is a good harvest, supply will increase, which should decrease the price of soybeans. If it is a poor harvest, supply will decrease, which should increase the price of soybeans. October, November & December: Autumn in the Northern Hemisphere is harvest time for soybeans. The soybean harvest has a direct impact on supply in the market. If it is a good harvest, supply will increase, which should lower the price of soybeans. If it is a poor harvest, supply will fall, which should increase the price of soybeans. Wheat - The top three global producers of wheat are as follows: China India Russia July, August & September: Summer in the Northern Hemisphere is traditional harvest time for wheat. The wheat harvest has a direct impact on supply in the market. If it is a good harvest, supply will increase, which should decrease the price of wheat. If it is a weak harvest, supply will decrease, which should normally increase the price of wheat. October, November & December: Autumn in the Northern Hemisphere is planting time for wheat. The wheat planting season has a direct impact on supply in the market. If it is a productive planting season, supply will increase, which should decrease the price of wheat. If it is a bad planting season, supply will decrease, which should increase the price of wheat. Corn - The top three global producers of corn are as follows: United States China Brazil April, May & June: Spring in the Northern Hemisphere is planting time for corn. The corn planting season has a direct impact on supply in the market. If it is a strong planting season, supply will increase, which should result in a decrease the price of corn. If it is a poor planting season, supply will decrease, which should increase the price of corn. Spring in the Southern Hemisphere is harvest time for corn. The corn harvest has a direct impact on supply in the market. If it is a good harvest, supply will increase, which should decrease the price of corn. If it is a poor harvest, supply will decrease, which should increase the price of corn. October, November & December: Autumn in the Northern Hemisphere is harvest time for corn. The corn harvest has a direct impact on supply in the market. If it is a good harvest, supply will increase, which should decrease the price of corn. If it is a poor harvest, supply will decrease, which should increase the price of corn. Sugar - The top three global producers of sugar are as follows: Brazil India China January, February & March: Winter in the Northern Hemisphere is harvest time for sugarcane and sugar beets. The sugarcane and sugar beet harvest has a noticeable impact on supply in the market. If it is a good harvest, supply will increase, which should decrease the price of sugar. If it is a poor or weak harvest, supply will decrease, which normally should increase the price of sugar. April, May & June: Spring in the Northern Hemisphere is planting time for sugarcane and sugar beets. The sugarcane and sugar beet planting season has a direct impact on supply in the market. If it is a productive planting season, supply will increase, which should decrease the price of sugar. If it is a poor planting season, supply will decrease, which should increase the price of sugar. Autumn in the Southern Hemisphere is harvest time for sugarcane and sugar beets. The sugarcane and sugar beet harvest has a direct impact on supply in the market. If it is a good harvest, supply will increase, which should decrease the price of sugar. If it is a poor harvest, supply will decrease, which should increase the price of sugar. July & August: Winter in the Southern Hemisphere is also harvest time for sugarcane and sugar beets. The sugarcane and sugar beet harvest has a direct impact on supply in the market. If it is a strong harvest, supply will increase, which should decrease the price of sugar. If it is a poor harvest, supply will decrease, which should increase the price of sugar. October, November & December: Autumn in the Northern Hemisphere is also harvest time for sugarcane and sugar beets. The sugarcane and sugar beet harvest has a direct impact on supply in the market. If it is a good harvest, supply will increase, which should lower the price of sugar. If it is a poor harvest, supply will fall, which should increase the price of sugar. Spring in the Southern Hemisphere is planting time for sugarcane and sugar beets. The sugarcane and sugar beet planting season has a direct impact on supply in the market. If it is a productive planting season, supply will increase, which should decrease the price of sugar. If it is a poor planting season, supply will decrease, which should increase the price of sugar. Coffee - The top three global producers of coffee are as follows: Brazil Vietnam Colombia July & August: Winter in the Southern Hemisphere is harvest time for coffee. The coffee harvest has a clear impact on supply in the market. If it is a strong harvest, supply will increase, which should decrease the price of coffee. If it is a bad harvest, supply will decrease, which should increase the price of coffee. October, November & December: Spring in the Southern Hemisphere is blooming time for coffee. The coffee blooming season has a direct impact on supply in the market. If it is a good blooming season, supply will increase, which should decrease the price of coffee. If it is a bad blooming season, supply will decrease, which should increase the price of coffee. Cotton - The top three global producers of cotton are as follows: China India United States April, May & June: Spring in the Northern Hemisphere is planting time for cotton. The cotton planting season has a direct impact on supply in the market. If it is a strong planting season, supply will increase, which should decrease the price of cotton. If it is a poor planting season, supply will decrease, which should increase the price of cotton. October, November & December: Autumn in the Northern Hemisphere is harvest time for cotton. The cotton harvest has a direct impact on supply in the market. If it is a good harvest, supply will increase, which should decrease the price of cotton. If it is a weak harvest, supply will decrease, which should increase the price of cotton.
Who cares about what happened yesterday? The markets are like the dice in a crap game. They have no memory. Only we do. What happened in the past has no known effect upon the market. But our memories are strong. We would like to think that history matters. Then we can worry and speculate about the effects of yesterday's events upon today's market. The Great Financial Crisis of 2008 signaled to many the end of the bull market. They looked back to the events following the crash of 1929 and clearly saw how the future would unfold. Wrong! Instead the market steadily gained strength and continued on its merry way. Those who kept thinking about the past couldn't believe their eyes. If they thought that there were parallels between the crash of 1929 and the crash of 2008 and that the market would follow a similar pattern, they were badly punished. If they played the short side of the market, they were severely punished. Those who say that they couldn't believe the market could recover from such a severe blow and go on to post new historical highs missed yet another great opportunity. Every moment is unique, and every market is very different. Predictions about the future based upon similarities to the past are worthless. Believe what you see, not what you think. If seeing is believing, then we have to learn to accept what we see.
Disclaimer: I ain't no options guru, especially when it comes to the greeks. So exercise your own due dilligence. Delta: Just how much of the move did you get for all that money you poured in? Theta: Time is option seller’s best friend, but option buyer’s nightmare. Vega: Volatility is option buyer’s best friend but option seller’s nightmare. Q: So if I believe a stock was going to break out to a new high, I could buy the stock’s Call option and get a huge amount of leverage with much less capital, right? A: Yes, and also a much bigger percentage return on the capital you are using. You do not have to purchase the options until the stock actually breaks out. But if you do buy options at the price of the break out and you are correct, then you get the full intrinsic value of the move above the breakout, after having bought the options for their time value only. Q: So all Call options that are higher than the current price of the stock are only worth time value? How is time value derived? A: The time value is based on variables, like Historical Volatility and Implied Volatility, current price of the underlying asset, strike price, risk free rate of return and the probability of the option being in-the-money. There is a complex formula, which is probably only understood by math whizzes, but you can get a good understanding of a stock’s Theta value by looking at an option chain. The at-the-money options have the highest time value because when they are at-the-money, they have a 50/50 chance of going in-the-money. As you go farther and farther out-of-the-money the probability becomes less and less. It is possible that a two strike out-of-the-money option might only have a 25% chance of going in-the-money, so it could be priced at half as much as the at-the-money option. Q: What about in-the-money options time value? A: If you look at the in-the-money options in the chain, you will notice that the time value gets less and less as you go deeper and deeper in-the-money. Go deep enough in-the-money and you will have pure intrinsic value and no time value. The reason that there is little time value in deep in-the-money options is that there is very little chance that they will expire worthless. At expiration the value of these options is not determined by whether or not they are in-the-money but how deep they are in-the-money. Trading deep in-the-money options is almost the same as trading the stock itself, which has zero time value. The value of these options is almost entirely dependent on the movement of the stock’s price regardless of the amount of time that passes, whereas the passage of time has an equal chance of causing at-the-money options to either expire with intrinsic value or worthless. The buyers of these options can get the full move of the underlying with a relatively small amount of capital compared to trading the shares at their full value. Those buyers have the risk of the price moving in the opposite direction, but their risk is much more limited than being long or short the underlying shares; and because the options have very little time value, they experience very little time decay. For example, Call sellers have already been paid to give up any upside trend, but instead of selling time value, as they would with at-the-money options, they are selling intrinsic value. As long as the underlying shares do not increase in price, the sellers make a profit. Q: Do you have any ideas about ways to make Theta trades with options? A: Well, you know long options are long Theta and short options are short Theta. Each day an option deteriorates at the rate of its Theta. An option’s time value is usually, but not always, worth less at the close than it was worth at the open because the time available for it to be profitable is less by one day. If the underlying price remains stable, an option contract with a Theta of -0.12 will lose $0.12 of its value every day, even on weekends and market holidays. This rate of decay accelerates in the last month before expiration, as the odds of the underlying price changing become much lower as expiration day approaches. Many option traders avoid going long options in the last month to avoid the majority of the time decay. Also, many option traders like to sell options in the last month before expiration so they can profit from time decay. I sometimes sell weekly options where Theta is very generous. Q: It almost seems like every time I buy options, Theta eats up the value, even when I am correct about the direction of a trend. I understand how Delta works with options, but Theta has always been a more difficult subject for me. A while back, I bought 1,000 shares of stock on a breakout and it did really well in the first week. But the gains were all on low volume, so I was fairly confident that the trend was going to reverse. I wasn’t ready to sell at that point because the stock was only a couple of weeks away from the ex-dividend date and holding onto the shares would have qualified me for a substantial profit. Thinking that I could lock in the profit by buying at-the-money Puts, I looked up the Greeks. The Puts showed a Delta of 0.50, so I bought 20 contracts. I thought I was Delta-neutral; if the stock price went down $1, I would lose $1,000 of my gains on my 1,000 shares, while my Puts would go up in price by fifty cents because their Delta was 0.50; and because my 20 contracts covered 2,000 shares, I thought I would recover that $1,000. As it turned out, I was partially correct. The stock price fell $1 over the next week, but my Puts only went up in value by $500. I ended up selling everything at a $500 loss and that caused me to also miss out on the dividend. It seemed like I made the right decision, creating a Delta-neutral position, but Theta decay ate up all of my profits. A: Time decay, or Theta, is really the most important concept in all of option trading. Option prices are determined by risk, and risk in the markets is simply a factor of the uncertainty of how time will affect prices. Delta, Gamma, Vega, and all of the other Greeks are nothing more than different ways of expressing the effect of the time related risk of being long or short on any particular option. An understanding of Theta is the key to success with options. You can spend time researching all of the Greeks, but in the end, I think you will find, as I have, that they are all derivatives of Theta. I discovered option trading to be much simpler when I made Theta my main focus. I think Theta may be the reason why your trade failed. You were initially correct in your assumption that your position was Delta neutral. But your position was not Theta neutral; the time value of the options you purchased was decaying every day you owned them. To be Theta neutral, you would need to sell time value in order to offset the time value you were buying. Instead of buying 20 Put contracts, you could have made your position Theta neutral by buying 10 Puts and selling 10 Calls. But I should point out that the option market is very efficient, and it considers everything that affects the price of the underlying stock, including dividends. On the ex-dividend date, a stock is expected to fall in price by the amount of the dividend, or at least a portion of that amount. That makes Puts more expensive than they would be otherwise, while Calls get cheaper. It is likely that buying 10 Puts at an inflated price due to the anticipated dividend and selling 10 Calls at a discounted price would result in a net cost approximately equal to the dividend. Q: Anything else I should know about? A: You probably know that selling options is most profitable when the Theta decay takes place the fastest, namely, the last month. Some traders even like trading the weekly options, which have even greater Theta decay. You could sell out-of-the-money options that you believe are above resistance and have a very low probability of getting there. You could sell those sucker bets, which is a high probability system, or you could sell both Calls and Puts at-the-money on a stock. This puts the odds in your favor—a Short Straddle. There is also a play called a Calendar Spread, where you buy a long term option and then sell a short term option at the same strike. You profit from the faster time decay of the shorter term option compared to the longer term option. The only losing scenario on a Calendar Spread occurs when the underlying shares move a huge amount in the short term and then level off or reverse the trend in the long term. Q: That all makes sense, putting the odds in my favor and benefiting from time ticking away. But I still don’t fully grasp the concept of Theta. Why is it that stock options with a monthly expiration only cost about twice as much as weekly options? Shouldn’t they cost four times as much? A: Time value simply represents the uncertainty of what effect time will have on a future event. I was thinking about time value just this past weekend. I had taken my pet tortoise for a walk and was sitting by the pool enjoying my margarita when I realized he had wandered off. I quickly got some of the other condo owners to help me search and we started fanning out in all directions. Luckily, we found him after just a few minutes, but we had to cover a large area to do so. Think of it this way. My tortoise usually walks very slowly, constantly changes direction, and sometimes stops altogether, just as stock prices do. But when he wandered away, the area we had to search became larger and larger as time went by. The search area represents the uncertainty of his location due to the passage of time. As it turned out, we had to search a rather large area, but in reality he was not very far away when we found him. Ultimately, it is his distance from my chair that normally concerns me; his distance from my chair by the pool. It is the same with options. You are not concerned with the amount of area of uncertainty of the underlying price during the contract, only the distance the price might move from its starting point. Q: So how does it relate to Theta exactly? A: Do you remember learning in math class how the area of a circle is . I even had one math teacher who would always follow that equation with the remark, “No, they aren’t; pie are round.” I don’t think any of us ever laughed at his attempt to be a comedian, but it was his way of trying to get us to remember the equation. It is important because the area of a circle is related to the square of the radius; or to put it another way, the radius of a circle is related to the square root of the area. If the area of a circle becomes four times larger, the radius doubles because 2 is the square root of 4. So when we were searching for my tortoise, as time went by we had to expand our search over a larger and larger area, even though his distance from my chair was not increasing very fast. Think of the effect of time on stock prices like the search area for a tortoise. As time goes by, the area of the circle that would represent the search area grows, but you are only concerned with the distance of the stock price from its starting point, which is the square root of that area. The distance of a stock price from its starting point is its ‘speed’ or volatility, multiplied by the square root of time. Q: Now I think I am starting to understand. Stock prices don’t just go up or down consistently; they meander around, like your tortoise does when you take him for walks. So while they cover a larger and larger area as time goes by, the prices do not change nearly as fast as the area they cover. If I understand correctly, predicting a stock price four weeks away would involve four times the search area of predicting the price one week away. But the square root of 4 is 2, so the uncertainty of the price four weeks out would be about double the uncertainty of the price a week away. It also explains why a lot of the monthly options are about double the price of weekly options because the uncertainty is not four times as much, but two times greater. A: Yes, but only for at-the-money and out-of-the-money options. Intrinsic value on in-the-money options is the same no matter what their expiration date. So although the time value would still be double on the monthly in-the-money options, the actual premium would not be twice as much as the weekly ones because a portion of the premium would be based on the same intrinsic value. Deep in-the-money options, having very little time value, might have similar premiums despite having different expiration dates.
I'd be interested in this if you get a chance one day. Your teaching (or sharing) style is good because you dont assume that the basics are too obvious to be restated and the ratio of words to visuals is well balanced. Edit to say I see you began to expand on this later in the thread.
Everything we see is in the past. Once it happens it's history. That is all we have to try to judge the future. There is no now (now never comes), just what has happened and what might happen next. How far back one looks, is a matter of timeframe traded.
Well, that wasn't exactly what it meant (or so I'm led to believe). It's more to do with inflexibility than looking into the past. In short, don't get married to the stock you're investing. Don't get so fixated on your past winners. Don't believe the past will repeat itself in the way YOU believe it will. So on and so forth. Other that that, yes, I agree with you that you shouldn't neglect the past. It's there for a reason and, as they say, those who ignore the past are doomed to repeat their stupidity.
"The present moment holds the key to liberation. But you cannot find the present moment as long as you are your mind. To the ego, the present moment hardly exists. Only past and future are considered important. This total reversal of the truth accounts for the fact that in the ego mode the mind is so dysfunctional. It is always concerned with keeping the past alive, because without it—who are you? It constantly projects itself into the future to ensure its continued survival and to seek some kind of release or fulfillment there. Even when the ego seems to be concerned with the present, it is not the present that it sees: It misperceives it completely because it looks at it through the eyes of the past." — Eckhart Tolle In another word, let the market reveal the directions as to what course of action you should take. Do not impose your myopic views on the market. The problem is that we all bring to the market a set of preconceived notions that just doesn't work. We must first rid ourselves of these dangerous forms of self-deception before we hear the market's call. Until we let go of the false ideas of what makes the market tick and simply respond as the market unfolds, we will continue to be punished. When this is accomplished, we can begin to live and focus in the present moment. The promise of this approach is that once the nature of the beast within is recognized for what it is and we understand the dimensions of its powerful grip on everything we do, we will be able to grasp the flow of the market and be on our way to becoming successful.