This Day On The Street
Continue to site right-arrow
ADVERTISEMENT
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
Stocks Under $10 with 50-100% upside potential - 14 days FREE!

Equity Correlation

Stocks in this article: FXE FXY IWM LOW YUM

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.

CLICK HERE TO VIEW VIDEO

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

Select the service that is right for you!

COMPARE ALL SERVICES
Action Alerts PLUS
Try it NOW

Jim Cramer and Stephanie Link actively manage a real portfolio and reveal their money management tactics while giving advanced notice before every trade.

Product Features:
  • $2.5+ million portfolio
  • Large-cap and dividend focus
  • Intraday trade alerts from Cramer
  • Weekly roundups
TheStreet Quant Ratings
Try it NOW
Only $49.95/yr

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
  • Upgrade/downgrade alerts
Stocks Under $10
Try it NOW

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

Product Features:
  • Model portfolio
  • Stocks trading below $10
  • Intraday trade alerts
  • Weekly roundups
Dividend Stock Advisor
Try it NOW

Jim Cramer's protege, 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
  • Alerts when market news affect the portfolio
  • Bi-weekly updates with exact steps to take - BUY, HOLD, SELL
Real Money Pro
Try it NOW

All of Real Money, plus 15 more of Wall Street's sharpest minds delivering actionable trading ideas, a comprehensive look at the market, and fundamental and technical analysis.

Product Features:
  • Real Money + Doug Kass Plus 15 more Wall Street Pros
  • Intraday commentary & news
  • Ultra-actionable trading ideas
Options Profits
Try it NOW

Our options trading pros provide daily market commentary and over 100 monthly option trading ideas and strategies to help you become a well-seasoned trader.

Product Features:
  • 100+ monthly options trading ideas
  • Actionable options commentary & news
  • Real-time trading community
  • Options TV
To begin commenting right away, you can log in below using your Disqus, Facebook, Twitter, OpenID or Yahoo login credentials. Alternatively, you can post a comment as a "guest" just by entering an email address. Your use of the commenting tool is subject to multiple terms of service/use and privacy policies - see here for more details.
Submit an article to us!

Markets

DOW 17,804.80 +26.65 0.15%
S&P 500 2,070.65 +9.42 0.46%
NASDAQ 4,765.38 +16.9840 0.36%

Brokerage Partners

Rates from Bankrate.com

  • Mortgage
  • Credit Cards
  • Auto

Free Newsletters from TheStreet

My Subscriptions:

After the Bell

Before the Bell

Booyah! Newsletter

Midday Bell

TheStreet Top 10 Stories

Winners & Losers

Register for Newsletters