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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surfwon's picture



can you explain the trade more in depth please?

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.

Gubbmint Cheese's picture

you owe me a new keyboard...

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

B-rock's picture

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

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. 


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:

Silver Kiwi's picture

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

swissinv's picture;ran...^xau;indicator=volume;charttype=line;crosshair=on;ohlcvalues=0;logscale=off;source=undefined

(XAU index used as proxy for gold)

TradingJoe's picture

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

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).

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.

Tyler Durden's picture

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

Goldtoothchimp09's picture

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

Jack Kreuz's picture

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

Gubbmint Cheese's picture

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

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?!?!

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.

virgilcaine's picture

DC/Athens here we come.

4shzl's picture

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


cosmictrainwreck's picture

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

Bay of Pigs's picture

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

Completely. Fucking. Stupid.

virgilcaine's picture

DC/Athens here we come.

Bard's picture

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

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

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.

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 . . .

DavidC's picture

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


RobotTrader's picture

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

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."

lieutenantjohnchard's picture

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

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.

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.

malek's picture

But I agree, for the decade ending yesterday.

Dick Darlington's picture

Obummer - leaving no stock behind

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.

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?

Shock and Aweful's picture

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

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.

gatorontheloose's picture

shorts can breath again

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.