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Delayed MOMO Knee Jerk Reaction To "Fluff Compromise" Breaks ES-RISK Correlation

Tyler Durden's picture


You guessed it: the second the headline scanning momos and HFTs got wind about the new debt program, despite it being out there for over an hour, the market surged. But only stocks. The broader representation of risk has barely budged. Is this divergence sustainable? Who knows (except for Brian Sack of course). Those who can recreate the RISK basket synthetically may wish to contiune the trend of profitable compression trades between reality and momo stupidity.


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Tue, 07/19/2011 - 13:54 | 1471049 surfwon
surfwon's picture



can you explain the trade more in depth please?

Tue, 07/19/2011 - 14:09 | 1471114 plocequ1
plocequ1's picture

I can explain. You press the buy button when you want to buy a stock and you press the sell button when you want to sell.

Tue, 07/19/2011 - 14:10 | 1471130 Gubbmint Cheese
Gubbmint Cheese's picture

you owe me a new keyboard...

Tue, 07/19/2011 - 14:26 | 1471203 plocequ1
plocequ1's picture

piece of cake Gordon

Tue, 07/19/2011 - 14:27 | 1471210 French Frog
French Frog's picture

Posted last week....

Dear ZH,

I'm very much enjoying those arbitrage trades between the ES and your RISK index. I suspect that the vast majority of readers or traders in here do not have access to a RISK chart let alone being able to trade it.

It would be good if you could run some charts to see what other more 'common' instrument is currently the most corelated to the RISK index (it used to be Aud/Jpy I believe).

Once we know that, I feel that more people would benefit from this info as you could then do the pair hedge/trade with minimal risk (ie. short ES & long 'that' instrument), rather than simply going for the more risky 1 trade (in this instance, short ES, as many people have probably been burnt shorting the indices 'naked', especially when one remembers the many meltup mondays that we've had).

Just a thought, because the 'easy money' title is only correct IF you are able to trade it in reasonable safety by being hedged.

Thanks in advance

Tue, 07/19/2011 - 14:41 | 1471274 B-rock
B-rock's picture

Keep an eye on TZA and ride it up as ES reverses and drops.  EASY. EASY. EASY.

Tue, 07/19/2011 - 15:04 | 1471404 monkeyshine
monkeyshine's picture

This makes me ill. I would short the S&P here except 1) I just got stopped out of my S&P shorts I put on last week and 2) I think there are more legs here.

The plan that came out today got zero votes in the house last time it was proposes - it is only modestly different this time. The House wants to flex its muscles and pass its own bill not a Senate bill.  Obama speaking on a likely DOA bill coming from his former chamber, plus tech profits, sends this market into nosebleed.  I suspect we will hit some new 1 year highs as the news stream keeps coming. Stocks making profits from weak dollar and willingness to keep 10% unemployed.  That means chronic unemployment, not a good long term strategy for the country but who cares we're only talking about the stock market. 

Anyway, any kind of hint at a compromise will keep markets up.  If Aug 2 comes and goes, they will find a way not to default anyway. And if the House passes a bill to raise the debt ceiling $250 billion it will be enough to stave off disaster for 6 months and the markets will rally on that, even if Obama threatens a veto.  This is a market looking for any tidbit of good news to explain its irrational levity. 


Tue, 07/19/2011 - 19:33 | 1472003 swissinv
swissinv's picture

Everybody pretends to be on the top of this topic but I bet only few really understand how this arbitrage model is exactly working. To be honest with you, I'm also not sure if my understanding is correct, but I provide herewith at least my input to start a constructive discussion (thus feel free to correct me or further elaborate).

First, it looks like that most users are just playing one side of the trade. They go long the S&P500 if the ESU is below the risk basket and go short if the ESU is above the risk basket. However, this one side play is not arbitrage and does certainly not guarantee any profits. Obviously, we also have to trade the risk basket to earn the spread.

The risk basket includes is a correlation mix of the following components: AUDJPY, EURJPY, Gold, Oil, 10Y TSY yield, 2s10s30s TSY butterfly spread, DXY, and 2Y US-EU swap spread. These components are derived from a multiple regression against the ESU (and the correlation coefficient change on a daily basis). Fortunately, we don't need to care about the math and the correlation coefficients are simply used to create a proxy for the S&P500 (the risk basket). Since there are too many components to exactly replicate risk trade/spread, we also don't need to know any weights or correlation coefficients.

What we have to understand it the "ETF Capital Structure Arb" concept of the founders (capital context) which involves the following ETF to arbitrage the spread: (SPDR S&P 500) (iShares iBoxx $ Investment Grade) (iShares Lehman 7-10 Year Treasuy)

I understand that the main driver for capital flows is the spread between corporate bonds and US treasuries. If the spread widens, money flows into corporate bond market. If the credit spread tightens, money flows out from bond market into equities. If there is any manipulation of interest rates or equity prices, the S&P500 is getting out of sync with the proxy index (risk basket) but the firms capital structure brings it back to equilibrium represented by the risk basket.

So I understand that if:

ESU > RISK: selling 4 units of SPY, selling 9 units of EIF and buying 12 units of LQD

ESU < RISK: buying 4 units of SPY, buying 9 units of EIF and selling 12 units of LQD

(ratio and weighting fits with duration differentials and empirical cycles and I assume they can be considered as constant)

There are other combinations of ETF depending on the time horizon of the trade. See:

Tue, 07/19/2011 - 18:05 | 1472092 Silver Kiwi
Silver Kiwi's picture

Tyler, can you do a chart with the SPX & Gold & Silver?

Tue, 07/19/2011 - 19:24 | 1472294 swissinv
swissinv's picture;ran...^xau;indicator=volume;charttype=line;crosshair=on;ohlcvalues=0;logscale=off;source=undefined

(XAU index used as proxy for gold)

Tue, 07/19/2011 - 13:55 | 1471056 TradingJoe
TradingJoe's picture

Yoyo "market", lost 95 yesterday made, so far, 185 today, lets see where it closes!:))

Tue, 07/19/2011 - 13:56 | 1471063 THEOKOLES
THEOKOLES's picture


Tue, 07/19/2011 - 13:59 | 1471079 papaswamp
papaswamp's picture

Sell the fucking spike (STFS)! Before everyone reads the dam thing and realizes deficit will still be running close to $1 Trillion (especially when the HC kicks in).

Tue, 07/19/2011 - 13:59 | 1471081 Western
Western's picture

So.. short SPY?

That's what I get out of these divergence posts, it seems once the compression catches up SPY goes down.

Tue, 07/19/2011 - 14:05 | 1471098 Tyler Durden
Tyler Durden's picture

Be careful with that as the two can converge to the upside as both rise.

Tue, 07/19/2011 - 14:09 | 1471119 Goldtoothchimp09
Goldtoothchimp09's picture

what essentially consists of the "risk basket" -- i would guess some currency, commodity etc.??

Tue, 07/19/2011 - 14:11 | 1471131 Jack Kreuz
Jack Kreuz's picture

AUDJPY, EURUSD, 10 year, 2s10s30s, Oil and Gold

Tue, 07/19/2011 - 14:11 | 1471135 Gubbmint Cheese
Gubbmint Cheese's picture

it puts the lotion in the risk basket or it gets the hose again...

Tue, 07/19/2011 - 14:24 | 1471191 4shzl
4shzl's picture

ROFLOL!  Priceless.

Tue, 07/19/2011 - 21:48 | 1472635 FUN160
FUN160's picture


Tue, 07/19/2011 - 14:06 | 1471107 Goldtoothchimp09
Goldtoothchimp09's picture

Yes, short spy -- unless the other part of the spread rises to close out the divergence...not sure anyone knows what the other side of the spread consists of?!?!

Tue, 07/19/2011 - 22:58 | 1472781 FUN160
FUN160's picture

It's a spread. If you can't/won't trade it as an arbitrage, these posts should be read for entertainment purposes only. Taking only one side of a spread trade is death.

I need to do some more work, but I think I've got a decent risk basket to take the other side of the ES.

Good luck to those of you trying to figure it out.

Tue, 07/19/2011 - 14:00 | 1471086 virgilcaine
virgilcaine's picture

DC/Athens here we come.

Tue, 07/19/2011 - 14:00 | 1471087 4shzl
4shzl's picture

30-yr. Treasury back from "the slaughterhouse."  LOL.  Gotta luv dem bonds -- just ask Lacy:


Tue, 07/19/2011 - 14:07 | 1471109 cosmictrainwreck
cosmictrainwreck's picture

yeah - WTF? used to be inverse corr. now stocks & bonds run in tandem. welcome to...........(?).......

Tue, 07/19/2011 - 14:30 | 1471226 Bay of Pigs
Bay of Pigs's picture

USD just sitting there doing nothing. Where's that "strong doelarr" correlation?

Completely. Fucking. Stupid.

Tue, 07/19/2011 - 14:01 | 1471092 virgilcaine
virgilcaine's picture

DC/Athens here we come.

Tue, 07/19/2011 - 14:01 | 1471093 Bard
Bard's picture

Im glad to see corection in gold - i was wishing to see gold around 1450$ during the summer.

Tue, 07/19/2011 - 14:08 | 1471117 geminiRX
geminiRX's picture

You still might. Summer doldrums have a stark reputation of taking people out to the woodshed. Ive learned my lesson to not trade the shiny stuff over summer

Tue, 07/19/2011 - 14:09 | 1471099 4shzl
4shzl's picture


Tue, 07/19/2011 - 14:07 | 1471104 RobotTrader
RobotTrader's picture

Treasuries going vertical.

They are selling gold and buying more Uncle Gorilla notes.

5-yr. yield remains pinned near 45-year lows.

Tue, 07/19/2011 - 14:14 | 1471143 4shzl
4shzl's picture

Low yield for the 5-yr. was 1.33% IIRC.  Goldscum recommended shorting it @ 1.70% -- so consistent, so painful.  Amazing one of their "clients" hasn't gone postal yet . . .

Tue, 07/19/2011 - 14:07 | 1471110 DavidC
DavidC's picture

So, apart from Benny's QE3 that's the last of the bullets shot, isn't it?


Tue, 07/19/2011 - 14:08 | 1471116 RobotTrader
RobotTrader's picture

Looks as if the Sunday night lows for EUR/CHF may be in for the decade.

Tue, 07/19/2011 - 14:18 | 1471160 lieutenantjohnchard
lieutenantjohnchard's picture

robotard furiously surfing the internet making one internet post after the next in the customer service lobby of a bank while customers stack up in the lobby. "i'll be right with you, sir. i'm finalizing the terms of a syndicated loan for a hnw client."

Tue, 07/19/2011 - 14:25 | 1471193 MsCreant
MsCreant's picture

You are unrelenting. LMAO!

Tue, 07/19/2011 - 14:33 | 1471240 lieutenantjohnchard
lieutenantjohnchard's picture

you've really got to wonder who is supervising the 'tard.

Tue, 07/19/2011 - 14:54 | 1471373 JohnG
JohnG's picture

Nobody.  He sits in his "600 sq. ft. apartment overlooking the LA freeway" with his dick in one hand and spewing shit with the other.


I already told you to fuck off robotard and I hate repeating myself.

Tue, 07/19/2011 - 15:02 | 1471397 lieutenantjohnchard
lieutenantjohnchard's picture

you must have missed the memo. he went to work (i use the term "work" loosely given his serial posting) as a contract 1099 processor for a commercial bank in the greater LA area. he said he has a state of the art 4 monitor work station in a corner office. so i had to revise and extend my "600 square feet apartment" remarks to more accurately reflect his walter mitty fantasy world.

Tue, 07/19/2011 - 15:08 | 1471416 Ponzi Unit
Ponzi Unit's picture


Tue, 07/19/2011 - 18:35 | 1472165 malek
malek's picture

But I agree, for the decade ending yesterday.

Tue, 07/19/2011 - 14:09 | 1471123 Dick Darlington
Dick Darlington's picture

Obummer - leaving no stock behind

Tue, 07/19/2011 - 14:12 | 1471138 monopoly
monopoly's picture

And they sell gold and miners because of the progress in the 3 ring circus. Well, this is good, weak players will be flushed out, then we can resume our regular programming.

And oil looking for 100 again. What a farce. Light volume, let the traders play, I am standing pat with what I got.

Tue, 07/19/2011 - 14:15 | 1471146 Hoody Who
Hoody Who's picture

I just keep stacking the physical.  I think my ASE's & my few AGE's will keep going up as the die-lution continues and the dollar continues to decline.  What-a-ya say?

Tue, 07/19/2011 - 14:15 | 1471147 Shock and Aweful
Shock and Aweful's picture

We are saved....thank you dear leader!!!

Tue, 07/19/2011 - 14:17 | 1471154 tmftdoyle
tmftdoyle's picture

The following sentance sums it all up as more tape painting BS.


The details of the changes would be left to congressional committees to draw up.

Tue, 07/19/2011 - 14:17 | 1471158 gatorontheloose
gatorontheloose's picture

shorts can breath again

Tue, 07/19/2011 - 14:25 | 1471181 hedgeless_horseman
hedgeless_horseman's picture

I cannot be certain, but big picture this all looks like a set-up, with failure to pass the debt ceiling (Red Team) as the fall guy for a big crash, and the excuse for more of the same debt slavery for decades to come.

Remember, the game is all about "our" debt, which is "their" asset.

Little picture, it looks like more cover for the bank stocks that have been getting smoked.

Tue, 07/19/2011 - 14:22 | 1471182 Johnny Lawrence
Johnny Lawrence's picture

I like the decoupling gold is finally showing with equities.  It's only been a few days, but for a long time, the correlation with the equity market was very strong.

Tue, 07/19/2011 - 14:42 | 1471300 sitenine
sitenine's picture

I'm still struggling with the whole debt backed currency idea in general; and since the USD is still the world reserve currency, the 'debt as money' idea world wide is worth debate. Gold is not money, but debt is. I heard the Bernank say so just last week. So, the more I owe, the richer I am? Does that make paying off debt a sin? Am I going crazy, or is it the rest of the world that has just simply forgotten what is and is not actually worth anything? Is it that the collective somehow believes that growth is guaranteed, even though we have neither the resources nor the educated populace to make it so? Why? What is so ingrained in the human psyche that makes us so stupid? How did we get to a point that the entire world looks to the US for nothing more than a dumping ground of reckless consumption? How did humanity ever come to believe that something for nothing is not only the norm, but a God given RIGHT!? How does this end? How do we continue to consume when there is nothing left to consume? Or do I have it all wrong?

Tue, 07/19/2011 - 15:03 | 1471402 hedgeless_horseman
hedgeless_horseman's picture

Double entry accounting. 
Our debt is their asset.  
We are being farmed for interest payments.

Tue, 07/19/2011 - 15:16 | 1471444 sitenine
sitenine's picture

Hmm, interest payments... Yes, I understand this well. Banks create principle. Of this I am certain. Who 'creates' interest though? Interestingly, it is not created by anyone. There is no mechanism to create interest, meaning the interest is paid back with freshly created principle. It follows, as a scientific fact, that when princple is not created then interest can not be paid. Guaranteed failure ensues unless perpetual growth really does exist. The word 'ponzi' comes to mind.

Tue, 07/19/2011 - 15:25 | 1471478 hedgeless_horseman
hedgeless_horseman's picture

Trust a congressman to explain it all:

The more debt we [nation] have the more wealth we [banks] have.

Tue, 07/19/2011 - 15:28 | 1471494 monkeyshine
monkeyshine's picture

Well the real answer there is that the money supply has to expand because the population expands and inflation demands that it expand, so as the supply of cash grows you have to get more of it. If there is a plague that wipes out 50% of the people in each country in a day would there be massive inflation or deflation? 

Tue, 07/19/2011 - 16:20 | 1471688 MsCreant
MsCreant's picture

Depends. Does the plague kill Ben, or not.

Tue, 07/19/2011 - 15:12 | 1471429 newworldorder
newworldorder's picture

Yours and our problem at ZH is that we look for a reality that is allegedly different than that of the average citizen.

Most, simply want to believe, because they have always believed. Somehow, the power structure finds a way to avert disaster. The majority do not want to know any alternate reality to "things will be all right."

Logic therefore dictates that if all is well, there is nothing to be gaining by worrying about it. The whole debt ceiling issue is a perfect case in point. the majority do not worry about the actual debt accrual, they worry only about Congress not voting to exceed the debt ceiling.

Tue, 07/19/2011 - 15:23 | 1471473 monkeyshine
monkeyshine's picture

Debt at this point is good depending on who you owe. If you owe your broker, because  you are leveraged long, that is good.  If you owe your banker on real estate, that is bad because there is no inflation there.  If you expect inflation, debt is generally good to take on now.  You will owe less later.  It all depends on how well you invest your debts.

For decades we got away printing excess dollars and selling US debt, and this worked because the world economy kept growing.  $500 billion here, $350 billion there, it would find its way into the hands of foreigners and so we never did see any serious CPI inflation.  We saw asset bubbles instead. That theory may still have legs, though, we are competing with the Euro now.  The dollar can make a comeback if it bottoms - it will attract investors.  Clearly our Federal Reserve doesn't feel now is the time for that though, and keeps printing.  Funny thing that we still debate whether we will face deflation. It is still a serious debate, though probably less so now than say 3 months ago.  But with mergers and buyouts and the lack of newcomers/entrepreneurs (due to the difficulty in raising capital despite lots of it floating around) it makes things more "fascist" if you excuse the word.  How long can the little and mid size business in any industry last if the large competitors can price them out of most commerce?  If you own 5 pizza shops you may do well but at some point Dominos, Papa John and the others are coming for you.  Expand or die.  If you are RC cola how do you compete with Coke & Pepsi.  How long will Chipotle last before Pepsico buys them?  How long will Cheesecake Factory go before they are acquired?  There was a really bad movie many years ago with Sly and Snipes that suggested one day in the future every restaurant will be called Taco Bell. 

Tue, 07/19/2011 - 14:49 | 1471340 Clowns on Acid
Clowns on Acid's picture

But Tyler - Jim Cramer told me to sell everything today. I did so this morning. Do you think he will take my call on his Show later today?

Tue, 07/19/2011 - 15:12 | 1471426 monkeyshine
monkeyshine's picture

I would not be so quick on the draw here. To each his own, but those who say sell this rally, I say not yet. Every market sell-off the last 7 days saw a comeback.  Even yesterday the S&P was down over 17 at one point to close only down 9.  This is a market looking for reasons, any reason, to rally.  It has been that way for a long time and the earnings + the idea of a debt ceiling/tax deal are more excuses.  Shorts have had their heads handed to them all year, unless you got exceptionally good timing.  I escaped with my hat on today only because of stops but saw a years worth of mortgage payments vanish at the same time, for not closing every short yesterday.  I did not expect a "gang of six" to rob me, nor for the President to mug for the cameras again, nor that tech profits (likely from overseas and enhanced by exchange rates) to cover up what obviously are deep problems in the rest of the economy.  Good luck.

Tue, 07/19/2011 - 15:28 | 1471495 Tyler Durden
Tyler Durden's picture

You are not selling a rally. That would mean standing in the way of the Printer. You are merely arbing euphoria which usually ends up catching up when the correlation desks look for mispriced assets following a break out such as this one.

Tue, 07/19/2011 - 18:15 | 1472120 monkeyshine
monkeyshine's picture

Understood, but this is way beyond my ability to be attentive to it, and limited by my technology at hand.  I am merely a businessman who gives his profits to the owners of HFT machines.

Tue, 07/19/2011 - 15:41 | 1471559 JimRogers
JimRogers's picture



I got a bad feeling about this one.


Thanks for the headsup nonetheless.



Tue, 07/19/2011 - 23:03 | 1472790 FUN160
FUN160's picture

There's nothing to have a bad feeling about, unless you believe the ES will suddenly decouple from the risk basket.

This post is not about naked shorting the ES, it's about the ES being expensive only in relation to the risk basket. They could reach parity tomorrow with the S&P (much) higher.

Wed, 07/20/2011 - 11:21 | 1473805 JimRogers
JimRogers's picture

Thanks for your thoughts.


I understand the trade perfectly. 


It's the confidence and the increased appearance that tweaked my skepticality bone.


Tue, 07/19/2011 - 15:56 | 1471604 speconomist
speconomist's picture

Tyler, an update please, has the spread closed?

Tue, 07/19/2011 - 16:41 | 1471771 Cplus
Cplus's picture

If the composition of the RISK basket becomes public, it is guaranteed that the trade will be rendered unprofitable for the short term.

At this time, the overwhelming majority of the market's energy is devoted to traders scalping the market participants who take positions for exogenous reasons.

Wed, 07/20/2011 - 00:01 | 1472871 tom
tom's picture

Oh, sorry, that was me. Anyhoo, I sold already.

Wed, 07/20/2011 - 00:17 | 1472896 andyupnorth
andyupnorth's picture

From which website could you draw a similar chart?

e.g. S&P500 vs AUD/JPY, not percentage change like how yahoo finance does it, short delay (e.g. 15 minutes)

I would rather not download a program, but if that's the only way, then fine.

Do NOT follow this link or you will be banned from the site!