Alert

Looking for even more trade ideas? Sign up for Alpha Boost, a FREE email from quiet foundation!

The Relationship Between Bond & Equity Prices | Market Measures

Feb 4, 2016

By: Sage Anderson

Today we are reviewing one of the more iconic relationships - the link between equity (stocks) and debt (bonds).

The big difference between stocks and bonds is that people who buy shares of stock are owners of the company while people who buy bonds are lending the company money. Generally, buying stock let’s you participate in the success or failure of the company as the stock price rises and falls, while buying bonds lets you collect interest and hopefully get your full principal back.

A stark illustration of this distinction can occur during bankruptcy, when stockholders are basically the last group to be paid out if there are remaining assets. Bondholders on the other hand are among the first to get paid.

Historically, there has been an inverse correlation between the movement of stock and bond prices. Before we examine why, let's first look at the historical data from a Market Measure that shows evidence of this trend. We’ll compare SPY for stocks with TLT for bonds.  The graphic indicates that over that time period, bonds and equities have had a negatively correlated relationship the majority of the time - meaning that as SPY goes up, TLT tends to go down, and vice versa.

ETF_bonds_SP500

Aside from illustrating the negative correlation between the TLT and the S&P 500, the above also reveals that during the spring of 2015, this inverse relationship had broken down to some degree.  

The tastytrade Market Measures episode referenced above goes into further detail about this shift and also discusses some ways that traders can go about taking advantage of that potential opportunity.

According to tastytrade research, over the last 10 years, TLT and SPY had a negative relationship (inverse correlation) on a 1-month basis on 82% of trading days. But why?

One reason is that earnings drive stock prices and interest rates drive bond prices. The performance of the economy, then, is the axis around which these two drivers revolve.

For example, when the US economy is acting poorly, central bankers tend to lower interest rates to help stimulate growth.  As interest rates go down, bond prices go up.

In contrast, stock prices generally go down when economic conditions erode. These realities therefore fit the hypothesis - declining economic conditions are typically paired with falling interest rates, rising bond prices, and declining equity prices.   

It's important to note that while the negative correlation between the TLT (bond prices) and S&P 500 (equity prices) may hold the majority of the time, there are instances where it breaks down.

On the Market Measures referenced earlier, tastytrade research shows roughly 91 occasions over the last 10 years (roughly 3.5% percent of trading days), the relationship between TLT and S&P 500 has actually been positively correlated - which was exactly the case in spring of 2015. This last piece of information is proof that dislocations do occur in even the stickiest of normal, or inversely, correlated products.

If you have any questions or comments regarding the relationship between bond prices and equity prices, please don't hesitate to contact us at support@tastytrade.com.

We look forward to hearing from you!

Sage Anderson has an extensive background trading equity derivatives and managing volatility-based portfolios. He has traded hundreds of thousands of contracts across the spectrum of industries in the single-stock universe.



tastytrade content is provided solely by tastytrade, Inc. (“tastytrade”) and is for informational and educational purposes only. It is not, nor is it intended to be, trading or investment advice or a recommendation that any security, futures contract, transaction or investment strategy is suitable for any person. Trading securities can involve high risk and the loss of any funds invested. tastytrade, through its content, financial programming or otherwise, does not provide investment or financial advice or make investment recommendations. Investment information provided may not be appropriate for all investors, and is provided without respect to individual investor financial sophistication, financial situation, investing time horizon or risk tolerance. tastytrade is not in the business of transacting securities trades, nor does it direct client commodity accounts or give commodity trading advice tailored to any particular client’s situation or investment objectives. Supporting documentation for any claims (including claims made on behalf of options programs), comparison, statistics, or other technical data, if applicable, will be supplied upon request. tastytrade is not a licensed financial advisor, registered investment advisor, or a registered broker-dealer. Options, futures and futures options are not suitable for all investors. Prior to trading securities products, please read the Characteristics and Risks of Standardized Options and the Risk Disclosure for Futures and Options found on tastyworks.com.

tastyworks, Inc. ("tastyworks") is a registered broker-dealer and member of FINRA, NFA and SIPC. tastyworks offers self-directed brokerage accounts to its customers. tastyworks does not give financial or trading advice nor does it make investment recommendations. You alone are responsible for making your investment and trading decisions and for evaluating the merits and risks associated with the use of tastyworks’ systems, services or products. tastyworks is a wholly owned subsidiary of tastytrade, Inc (“tastytrade”). tastytrade is a trademark/servicemark owned by tastytrade.

Quiet Foundation, Inc. (“Quiet Foundation”) is a wholly-owned subsidiary of tastytrade The information on quietfoundation.com is intended for U.S. residents only. All investing involves the risk of loss. Past performance is not a guarantee of future results. Quiet Foundation does not make suitability determinations, nor does it make investment recommendations. You alone are responsible for making your investment and trading decisions and for evaluating the merits and risks associated with the use of Quiet Foundation’s systems, services or products.

Small Exchange, Inc. is a Designated Contract Market registered with the U.S. Commodity Futures Trading Commission. The information on this site should be considered general information and not in any case as a recommendation or advice concerning investment decisions. The reader itself is responsible for the risks associated with an investment decision based on the information stated in this material in light of his or her specific circumstances. The information on this website is for informational purposes only, and does not contend to address the financial objectives, situation, or specific needs of any individual investor. Trading in derivatives and other financial instruments involves risk, please read the Risk Disclosure Statement for Futures and Options. tastytrade is an investor in Small Exchange, Inc.

© copyright 2013 – 2021 tastytrade. All Rights Reserved. Applicable portions of the Terms of use on tastytrade.com apply. Reproduction, adaptation, distribution, public display, exhibition for profit, or storage in any electronic storage media in whole or in part is prohibited under penalty of law, provided that you may download tastytrade’s podcasts as necessary to view for personal use.