Market Measures

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Diversification in Market Downturns

Market Measures

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The correlation of a stock or ETF that we are potentially looking to sell premium in to the broad equity market is very useful for a number of reasons. The correlation between a stock and the S&P 500 (SPY) tells us how that stock has acted relative to the equity market in recent months, either moving with the market, moving opposite the market, or having no relation at all. We like to trade underlyings that move with close to no relationship to the broad equity market as that contributes to diversification in a portfolio.

However, correlations are not static; they are changing constantly. Today, Tom and Tony look at how correlations have changed historically when the broad market has sold off. This was done to see what markets we can sell premium in along with our consistent short premium in SPY that will not go down with the equity market during a sell off.

The Study
  • 2010 to present
  • Compared S&P 500 (SPY) correlation to:
  • non-US Equity Indices (EFA and EEM)
  • Crude (USO), Gold (GLD), and Bonds (TLT)
  • Currencies (FXE and FXY)
The Results

To no real surprise, the abroad equity markets tended to act even more strongly with the market during selloffs. A similar result, but with less magnitude, was seen in crude oil. However, history showed us that the gold and currency markets tended to have no strong relationship to the market when it went down. These present good diversification options. Check out the segment above for further details.

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