Recently, we posted a piece on the blog that focused on insights gleaned from interest rate trends.
The focus of that blog post was research conducted by tastytrade that revealed patterns in global equity performance when interest rates are trending either up or down.
Using historical data, tastytrade found that when interest rates are trending higher in the United States, foreign equity markets tend to outperform the S&P 500. The reverse tends to occur when interest rates are falling (i.e. the S&P 500 outperforms foreign equity markets).
Today we are taking a closer look at emerging markets, and learnings from that post on interest rates tie in well with today's theme.
Interest rates in the United States have been rising since 2016, and the trend is expected to continue for at least the foreseeable future.
Given what we know about rising interest rates environments and the performance of foreign equity markets, it seems reasonable to speculate that the Emerging Markets ETF (EEM) has increased in 2017.
The chart pictured below confirms that the EEM has indeed done well throughout 2017, as has the China Large-Cap ETF (FXI):
Because interest rates are expected to continue to rise in the future, tastytrade decided to run a study on both EEM and FXI to better understand how a short premium strategy had worked in both products in recent years.
The results of the study, presented on Market Measures, may help traders better evaluate ongoing opportunities in foreign equity markets, should they find this niche attractive now or at some point in the future.
As noted on Market Measures, China accounts for almost 30% of the EEM, so it's certainly not surprising that FXI has risen alongside EEM in 2017.
To assess the relative performance of a short premium approaches in EEM and FXI, a study was designed with the following parameters:
Sold 16 delta strangles in EEM
Sold 16 delta strangles in FXI
Managed profits at 50% of the initial credit received
Used options with approximately 45 days-to-expiration (DTE)
Used historical data from 2011 to present
While we recommend watching the complete episode of Market Measures for the best possible understanding of the material, the study produced several important takeaways.
While the win ratio was above 90% for both strategies, the FXI showed a lower average P/L and a higher maximum loss. The Market Measures team inferred from these results that the broadened diversity of the EEM (more globally oriented), as compared to the FX, was likely a reason for this discrepancy.
In order to provide further perspective on this comparison another backtest was run, this time with a slight adjustment. In this case, the backtest included only occurrences when Implied Volatility Rank (IVR) was above 50.
The second phase of the study basically examined instances when implied volatility was inflated. This appears to have boosted the performance of both strategies. The average P/L and the win ratio improved for both the EEM and the FXI during the second backtest.
While each trader's unique risk profile and strategic approach will dictate whether an ETF tracking foreign equities is suitable for their volatility portfolio, the research presented on Market Measures can be useful in the evaluation process.
We hope you'll take the time to review the complete episode of Market Measures focusing on EEM and FXI when your schedule allows.
If you have any questions or comments, please leave us a message in the space below, or reach out directly at firstname.lastname@example.org.
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.