This Day On The Street
Continue to site
This account is pending registration confirmation. Please click on the link within the confirmation email previously sent you to complete registration.
Need a new registration confirmation email? Click here

Equity Correlation

This complimentary article from Options Profits was originally published on April 18. Don't risk missing over 40 options trade ideas every week, exclusive commentary and webinars from over 15 experts. Click here for more information and a 14-Day Free Trial.

Wednesday: Options Industry Council FREE Three-Part Webinar Series: Part Three, April 18 at 7pm ET. CLICK HERE FOR INVITE AND TO REGISTER.

Thursday: Volatility Is Not All The Same, April 19 at 5pm ET w/Russell Rhoads of the CBOE. CLICK HERE FOR INVITE AND TO REGISTER.

As Jill and I discussed in the video below, it's been fascinating to watch the swings in equity correlation over the last several months. Both realized correlation among the returns of S&P 500 components and changes in the forward-looking correlation implied by options markets give us some interesting things to watch.


The average one-month correlation among S&P 500 components was actually higher in the fall of 2011 that at any point in the past five years, including during the 2008-2009 financial crisis. Then rally into the end of the year and in the first quarter of 2012 pushed stock correlation toward 40%, which is much lower than average. The flat-to-down trading in recent weeks has pushed overall realized market correlation back toward ordinary levels closer to 60%.

Source: Thomson Reuters
S&P 500 Average 1M Stock Correlation

As we've noted before, paying attention to these swings in correlation is important because it tells us what kind of market we're dealing with. When average stock correlation is high, it means the market is being driven by exogenous, usually macroeconomic factors. In that kind of environment, paying attention to the fundamentals of individual companies is less important than getting the bigger picture in focus. When average stock correlation is low, it means that the price returns of any given stock are more likely to depend on fundamentals and earnings -- in other words, a low correlation market is a stock picker's market.

Right now, we're not at an extreme level of realized correlation in either direction, which means there is a mix of factors in play. One way we've been trading this type of market is by putting on both macro-focused trades and positions in stocks showing resilient momentum. For instance, we have positions open in CurrencyShares Euro Trust (FXE), CurrencyShares Japanese Yen Trust (FXY), and iShares Russell 2000 Index ETF (IWM), but also trades in specific stocks like Lowe's (LOW) and Yum! Brands (YUM).
Source: CBOE
S&P 500 Implied Correlation Index

As for option implied correlation, it looks like traders are pricing in lower stock correlation for the future. While one-year implied correlation remains above levels we say in the mid-2000s, perhaps reflecting higher concerns about persistent systemic risk, options markets are pricing in about the same expected 1Y correlation that we saw for most of 2011.
1 of 2

Check Out Our Best Services for Investors

Action Alerts PLUS

Portfolio Manager Jim Cramer and Director of Research Jack Mohr reveal their investment tactics while giving advanced notice before every trade.

Product Features:
  • $2.5+ million portfolio
  • Large-cap and dividend focus
  • Intraday trade alerts from Cramer
Quant Ratings

Access the tool that DOMINATES the Russell 2000 and the S&P 500.

Product Features:
  • Buy, hold, or sell recommendations for over 4,300 stocks
  • Unlimited research reports on your favorite stocks
  • A custom stock screener
Stocks Under $10

David Peltier uncovers low dollar stocks with serious upside potential that are flying under Wall Street's radar.

Product Features:
  • Model portfolio
  • Stocks trading below $10
  • Intraday trade alerts
14-Days Free
Only $9.95
14-Days Free
Dividend Stock Advisor

David Peltier identifies the best of breed dividend stocks that will pay a reliable AND significant income stream.

Product Features:
  • Diversified model portfolio of dividend stocks
  • Updates with exact steps to take - BUY, HOLD, SELL
Trifecta Stocks

Every recommendation goes through 3 layers of intense scrutiny—quantitative, fundamental and technical analysis—to maximize profit potential and minimize risk.

Product Features:
  • Model Portfolio
  • Intra Day Trade alerts
  • Access to Quant Ratings
Real Money

More than 30 investing pros with skin in the game give you actionable insight and investment ideas.

Product Features:
  • Access to Jim Cramer's daily blog
  • Intraday commentary and news
  • Real-time trading forums
Only $49.95
14-Days Free
14-Days Free
LOW $63.05 -1.60%
YUM $64.87 -2.80%
FXY $86.66 1.40%
FXE $111.10 0.58%
IWM $94.13 -1.80%


Chart of I:DJI
DOW 15,582.49 -332.25 -2.09%
S&P 500 1,819.32 -32.54 -1.76%
NASDAQ 4,228.7990 -54.7930 -1.28%

Free Reports