It wasn't long ago that we brought up the potential impact of a trade war on global GDP should events such as these actually come to pass.
We also noted that during the last two big corrections in US equity markets, one of them was precipitated by deteriorating GDP growth in the United States.
Since that time, the Trump administration has apparently decided to double down on tactics associated with negotiating new international trade deals. Since word first dropped about the sudden levying of new steel tariffs, President Trump and his advisers threw out yet another curve ball - this time relating to America's long-time trade deficit with China.
In order to supposedly level the playing field of international trade, or at least get the attention of the Chinese for the purposes of renegotiation, roughly $60 billion in Chinese imports were targeted with new tariffs. The neck-snap effect was apparent in Beijing, as the Chinese government quickly released a list of American goods exported to China that could receive similar tariffs (in response).
Interestingly, the Chinese appear to have selected manufacturing and farm-related American products; many coming from areas in which President Trump is perceived to have a strong political base. A clear message from the Chinese that they aren't taking the matter lightly.
While global equity markets had already experienced increased volatility in 2018, the prospect of a broad-based international trade war has clearly spooked them further. In recent trading sessions, equities have swung wildly in one direction or the other, seemingly based on the latest perceptions of the trade war.
While each and every trader has to decide if market conditions such as these match their risk profile and strategic approach, such saber-rattling can produce fresh opportunities in the market.
One trade to keep an eye on is gold, as recently highlighted on Market Measures. This episode should be particularly helpful for traders filtering the precious metals sector for new ideas.
A study is presented on the show which compares the historical performance of short premium strategies deployed across a handful of well-known securities in the precious metals sector. The data is then parsed further to isolate instances only in which IVR was elevated - and to see how that impacted the performance.
The graphic below shows how gold prices have steadily increased as the "trade war" story has developed:
The chart above matches previous tastytrade research which has shown that implied volatility in gold securities tends to rise along with prices. This is notable given the inverse correlation that is traditionally observed between equity prices and volatility.
Because the metals and mining sector is rather crowded, the Market Measures team decided to run a study which examined the historical success of short strangle approach in some of the best-known names (GLD, SLV, GDX, GDXJ, XME). The study was then re-run to examine how the strategy performed using only instances when IVR was greater than 50%.
For more information on all of the parameters used in the study please refer to the complete episode when your schedule allows.
The results from each leg of the study (1. all trades and 2. only those deployed when IVR was greater than 50%) are presented in the slides below. As you can see, performance was optimized when IVR levels were elevated:
While you may decide that current trading conditions don't fit the approach backtested on Market Measures, it's possible that this type of trade may become more attractive to you at some point in the future.
Given how quickly the global protectionist story has developed, it’s probable that a new wrinkle will materialize soon. President Trump has already foreshadowed that another $100 billion in tariffs could be levied if China responds in kind to the first wave of new taxes.
No matter what’s being said in the traditional financial media, it's worth monitoring gold for the foreseeable future and treating it much like a canary in the coal mine. The price of gold will likely provide more timely feedback on the state of market expectations more quickly than stories written by financial journalists.
If uncertainty persists, gold prices should climb further - along with implied volatility.
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.
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