INTER-MARKET & INTRA-MARKET RELATIONSHIP BY URIEL AMITAI

THE TECHNION ISRAEL - FINANCIAL WORKSHOP NOVEMBER 2010

Introduction

Uriel Amitai is Head of Research for Israel and Eastern Europe at GHF Capital. He has worked in the financial markets for 14 years and has traded Equities, Futures, Forex and Options on global exchanges. Prior to working at GHF, he worked at Merrill Lynch and JP Morgan.

uriel.amitai@ghfgroup.com

Questions First!

Who here knows what Euribor futures are? Who here knows what the Schatz futures are? Who here knows what spreads are? Who here uses statistical methods in there trading? Who here trades futures? Who trades forex? Who here trades equities? Who here knows what a Ted Spread is?

Contents

Product Overviews Basic Statistics Basics of Spreads Using Bloomberg HS Function Correlation - Searching for Relationships Working with Excel 2007 + Example Russell 2000 vs S&P500 Regression Analysis Practical application Charting Overlay Techniques Some More Market Relationships Commodity Dollar Rule Carry Trade Basics Knowing this relationship Credit Spread Using BoR-Schatz Spread White Sugar Raw Sugar Spreads Brent WTI Relationship

PRODUCT OVERVIEWS
Products used in this presentation topic EURIBOR, SCHATZ, SUGAR #11 , SUGAR #5

Euribor (Euro Interbank Offered Rate) is the rate at which euro interbank term deposits are being offered by one prime bank to another within the EMU zone. EURIBOR FIX 11am CET 3M Euro EURIBOR INTEREST RATE FUTURE Contract Size: 1m Value of 1pt = 2,500 Tick Size= 0.005 Tick Value = 12.50 Yield = 100 - Price

Euro-Schatz Futures

Euro-Schatz Future are futures contracts based on a notional short-term debt instruments issued by the Federal Republic of Germany, with a remaining term of 1.75 to 2.25 years. Notional coupon rate of 6% Contract Size= 100,000 Value of 1pt = 1,000 Tick Size = 0.005 Tick Value = 5.00

The Sugar No. 11 contract is the world benchmark contract for raw sugar trading. The contract prices the physical delivery of raw cane sugar, free on-board the receiver's vessel to a port within the country of origin of the sugar. SUGAR #11 (WORLD) TICKER = SB Contract Size = 112,000 lbs Value of 1pt = $1,120 Tick Size = 0.01 Tick Value = $11.20

WHITE SUGAR FUTURES (LIFFE) White beet or cane crystal sugar or refined sugar of any origin of the crop current at the time of delivery, free running of regular grain size and fair average of the quality of deliveries made from the declared Contract Size = 50 metric tons Value of 1pt = $50 Tick Size = 0.10 Tick Value = $5.00

Basic Theory- Statistics

Basic Statistics

Mean or Arithmetic Mean = Average value Median = Middle value Mode = most frequent value Standard Deviation = widely used measure of the variability or dispersion of data in trading it is a measure of price volatility and risk Correlation Coefficient = statistical relationships between two or more random variables or observed data values. Normal Distribution Curve = Bell Curve

Normal Curve
+/- 1 Std Dev = 68.2% of all observations

+/- 2 Std Dev = 95.4% of all observations

+/- 3 Std Dev = 99.7% of all observations

Scatter Plots and Basic Relationships

Defining Terms

Intra-Market Spread = same underlying market but different expiry months (Time spreads Corn Corn, Brent Brent, Euribor Euribor)

Inter Market Spread= Different underlying markets but same expiry months (sometimes may vary expiry months) (White Sugar Raw Sugar, Brent WTI, Euribor Schatz, Eurodollar 2Yrs, Crack Spreads, Eurodollar Euribor)

Spread Rules!

The basic parameters to remember in building spreads

Rule

to Remember! Pair Ratio = Price(1) / Price(2) Pair Spread = Price(1) Price(2)

Correlation Analysis

Determining Time Frame

Inter-market analysis looking for markets that are correlated this premise relies on that past relationships will be the same in the future Caveat Markets do CHANGE! First step in all this process is to decide weather you want to analyze data intraday, daily, weekly, monthly, quarterly basis One needs to check that correlations have remained steady over time Choice of time frames depends on the traders time horizons Correlations generally rise when weekly data replaces daily data

Life Made Easy For a Stat Arb Trader

Source: Bloomberg

Working in Excel Close Prices Yahoo

Data is the hardest thing to acquire US Daily data is available on Indexes Futures Data is a lot harder to work with

1. Data Capture Yahoo 2. Correlation Matrix Excel Correlation a) Closing Prices b) Returns

Running Models in Excel

Located in the Data Tab

Regression Analysis in Excel Contd

Regression on Returns (Dax vs Eurostoxx 50)

Source: Bloomberg

RUSSELL 2000 vs S&P 500

Chart Overlays
Tip on how to look at Overlays smooths out noise

Overlay Techniques

Tip when using overlay charts it helps to look at just moving Averages This technique helps to smooth price noise and provides a clearer picture for correlated price movements Charts to follow

COPPER vs EQUITIES

COPPER vs EQUITIES (10D SMA)

Market Relationships
Real Market Relationships

RULE: DOLLAR LOW COMMODITIES HIGH

GOLD vs SILVER RELATIONSHIP

CARRY TRADE
JPY carry trades When interest are at 0% what does that mean for a currency

Borrowing a given amount from a low interest-rate currency (funding currency), converting it into a high interest-rate currency (target currency) and lending the resulting amount in the target currency at a higher interest rate. Can be done between currencies of any two countries having an interest rate differential. Works best when done through a basket- that consists of combination of 3-4 high yielding currencies with 3-4 low yielding currencies.

Carry Trade Basics

Estimated that as much as Trillion is on the carry trade

EQUITIES, FOREX, TREASURY RELATIONSHIP

Equities up - Treasuries down (Price) - EURJPY up Equities down Treasuries up (Price) - EURJPY down

TIC FLOWS WHAT DOES IT MEAN?

http://www.ustreas.gov/tic/mfh.txt

The intermarket relationships from Treasury flows into Currency markets and equity with indirect effects into all other markets

Credit Spread or TED Spread

Bor Schatz Spread

Credit Spread Defined

The spread between Treasurys and non-Treasury securities that are identical in all respects except for quality rating. Quality Rating = Credit Risk = Credit Spread
TED came from where?

Regression Analysis Schatz vs 5th Euribor Contract

Source: Bloomberg

Regression on Returns

Source: Bloomberg

CREDIT SPREAD
3 Month Bubill Vs 3 month Spot Libor

CONTINUED. CREDIT SPREAD

6 Month Bubill Vs 6 month Spot Libor

CONTINUED. CREDIT SPREAD

1Yr. Bubill Vs 12month Spot Libor

CONTINUED. CREDIT SPREAD

2yr Swap Spread

Swap spread is a difference between the yield of a sovereign bond and interest rate swap for the same Tenure.

CONTINUED. CREDIT SPREAD

FEW INFERENCES

Credit Spreads for Eurozone during normal money market situations remainsbetween15-20basis pointsacross thecurve. Referring to current crisis, it can be inferred that it is not necessary that market factors in equal credit risk across the curve. This implies that Euribor spreads do have some component of such spread within them.

BOR-SCHATZ SPREAD
Brief understanding of how it can be traded : For Schatz futures, Price Value Basis Point (PVBP) falls around 1.84 2 (4 ticks) For Euribor, PVBP is 2 ticks Thus, shift in yield difference can be seen as
2 * Euribor 1 * Schatz futures (in price terms) Schatz futures yield -Euribor yield (in yield terms)

But, since contract values are different for Euribor and schatz, it

needs to be value hedged.

4 lots in Euribor= 5 lots in Schatz

Continued Bor-schatz Spread

If compared with complete Euribor Strip, the main cause for the

spread would be
CreditSpread

LiquidityPremium

However, if compared with a Single Euribor Contract, say 1st Red

Month contract (Duration greater than 1 Year) , then it has one additionalcomponent
Steepening/Flatteningofthecurve

Continued Bor-Schatz Spread

Schatz Yield Vs 2yr Yield as per Euribor Strip

Continued Bor-Schatz Spread

Schatz Yield Vs ER 5 Yield

White Sugar #5 Raw Sugar #11

White Sugar #5 Contract size 50 Metric Tons Quoted $/Mt Raw Sugar #11 Contract size 112,000 lbs Quoted Cents/ lbs
Are they Apples for Apples NO Conversion Factor = 22.0462 SB * CF = Raw Sugar in $/Mt (we are good to go)

#5 - #11 = Raw White Spread (Refining Margin)

Refiners Crack Front Raw Sugar Second White Sugar

Brent -WTI
Spread Calculated WTI - Brent

Brent TI Spread

THANK YOU
Questions?

Sources

Bloomberg Esignal Data Multicharts Yahoo Finance Exchanges: The Ice, Eurex, NYSE Euronext (LIFFE) Wikipedia http://www.wikipedia.org/ GHF Capital