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Neutral Trading Strategies for an Inactive Market

June 14, 2022 by Frank Kaberna| Tips & Strategies

What do you do when the dust settles, the smoke clears, and you’re left with middling markets? After quite a volatile May, June has seen the stock market bounce back (albeit slightly) and the US dollar cool off.

STIX & SFX \ Small Technology and Small US Dollar

Source: dxFeed (https://dxfeed.com)

Many traders hunt price extremes when looking for value in the market, but this strategy can leave you waiting on the sideline for extended periods. Pairs trades, or spread trades, as well as neutral options strategies can create opportunity out of a sideways, seemingly stagnant market.

How to Create A Pairs Trade

One of the most common ways to view pairs trade, or spread trade, opportunity is through the lens of convergence and divergence. You can look at two highly correlated products like stock futures or interest rate futures, measure how much they’ve converged or diverged, and then choose to go with or against such price action.

STIX-SM75 \ Small Technology – Small Stocks

Source: dxFeed (https://dxfeed.com)

For example, stock futures Small Technology (STIX) and Small Stocks (SM75®) have gone from trading around the same price a year ago to the former trading at a $35 discount. If you think the trend will continue, you can sell the underperformer (STIX) while buying the outperformer (SM75). Think the two markets will converge? You can buy STIX and sell SM75.

S30Y-S10Y \ Small 30YR Yield – Small 10YR Yield

Source: dxFeed (https://dxfeed.com)

A similar story is being told in the yield curve as US interest rates of varying duration flatten to historical lows. Traditionally, longer-term rates trade higher than shorter-term ones. Recently, however, the difference between 10YR and 30YR rates has come down to nearly 0% after trading at around a 0.7% premium of the latter over the former. This can be seen and traded in S10Y and S30Y futures. Think they’ll converge further and potentially invert the yield curve? You can sell S30Y and buy S10Y. Those thinking the curve will return to normal can do the opposite.

How to Create a Neutral Options Trade

Options derivatives can give you another opportunity to profit from a market remaining range bound. The short strangle includes a short call and put option and is a strategy rewarding the inactive market thanks to its neutral outlook.

SFX \ Small US Dollar with Strangle

Source: dxFeed (https://dxfeed.com)

As USD cools off from its bull run, a short SFX strangle (for example, -1 156 put and -1 161 call) could show potential if the forex market continues to coil. While the strategy can be expensive using stock or ETF options, a short strangle in SFX options is currently requiring between $100 and $200 in capital.*

Pairs trades and neutral options strategies alike can profit from markets trading in a range, and, if the summer continues to trend in this sideways direction, such opportunities could be booming.

 

*Values taken on 6/3/22 (July 15, 2022 Expiration)

—

To learn more about how the Small Exchange is merging the efficiency of futures with the clarity of stocks, make sure to subscribe to their YouTube channel and follow them on Twitter so you never miss an update.

© 2022 Small Exchange, Inc. All rights reserved. Small Exchange, Inc. is a Designated Contract Market registered with the U.S. Commodity Futures Trading Commission. The information in this advertisement is current as of the date noted, is for informational purposes only, not intended as a recommendation, and does not contend to address the financial objectives, situation, or specific needs of any individual investor.  The information presented here is for illustrative purposes only, and is not intended to serve as investment advice since the availability and effectiveness of any strategy is dependent upon your individual facts and circumstances. Trading in derivatives and other financial instruments involves risk.

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Filed Under: Tips & Strategies

About Frank Kaberna

Frank Kaberna is the head content strategist at the Small Exchange. He produces everything from brochures to videos that inform on the Small Exchange’s products. After earning a mathematics degree from the University of Michigan, Frank traded interest rates at the Chicago Board of Trade. He then worked on the tastytrade Network as a content producer and on-air talent before landing at the Small Exchange.

Risk Disclosure

The StoneX Group Inc. group of companies provides financial services worldwide through its subsidiaries, including physical commodities, securities, exchange-traded and over-the-counter derivatives, risk management, global payments and foreign exchange products in accordance with applicable law in the jurisdictions where services are provided. References to over-the-counter (“OTC”) products or swaps are made on behalf of StoneX Markets LLC (“SXM”), a member of the National Futures Association (“NFA”) and provisionally registered with the U.S. Commodity Futures Trading Commission (“CFTC”) as a swap dealer. SXM’s products are designed only for individuals or firms who qualify under CFTC rules as an ‘Eligible Contract Participant’ (“ECP”) and who have been accepted as customers of SXM. StoneX Financial Inc. (“SFI”) is a member of FINRA/NFA/SIPC and registered with the MSRB. SFI does business as Daniels Trading/Top Third/Futures Online. SFI is registered with the U.S. Securities and Exchange Commission (“SEC”) as a Broker-Dealer and with the CFTC as a Futures Commission Merchant and Commodity Trading Adviser. References to securities trading are made on behalf of the BD Division of SFI and are intended only for an audience of institutional clients as defined by FINRA Rule 4512(c). References to exchange-traded futures and options are made on behalf of the FCM Division of SFI.

Trading swaps and over-the-counter derivatives, exchange-traded derivatives and options and securities involves substantial risk and is not suitable for all investors. The information herein is not a recommendation to trade nor investment research or an offer to buy or sell any derivative or security. It does not take into account your particular investment objectives, financial situation or needs and does not create a binding obligation on any of the StoneX group of companies to enter into any transaction with you. You are advised to perform an independent investigation of any transaction to determine whether any transaction is suitable for you. No part of this material may be copied, photocopied or duplicated in any form by any means or redistributed without the prior written consent of StoneX Group Inc.

© 2023 StoneX Group Inc. All Rights Reserved

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Risk Disclosure

The StoneX Group Inc. group of companies provides financial services worldwide through its subsidiaries, including physical commodities, securities, exchange-traded and over-the-counter derivatives, risk management, global payments and foreign exchange products in accordance with applicable law in the jurisdictions where services are provided. References to over-the-counter (“OTC”) products or swaps are made on behalf of StoneX Markets LLC (“SXM”), a member of the National Futures Association (“NFA”) and provisionally registered with the U.S. Commodity Futures Trading Commission (“CFTC”) as a swap dealer. SXM’s products are designed only for individuals or firms who qualify under CFTC rules as an ‘Eligible Contract Participant’ (“ECP”) and who have been accepted as customers of SXM. StoneX Financial Inc. (“SFI”) is a member of FINRA/NFA/SIPC and registered with the MSRB. SFI does business as Daniels Trading/Top Third/Futures Online. SFI is registered with the U.S. Securities and Exchange Commission (“SEC”) as a Broker-Dealer and with the CFTC as a Futures Commission Merchant and Commodity Trading Adviser. References to securities trading are made on behalf of the BD Division of SFI and are intended only for an audience of institutional clients as defined by FINRA Rule 4512(c). References to exchange-traded futures and options are made on behalf of the FCM Division of SFI.

Trading swaps and over-the-counter derivatives, exchange-traded derivatives and options and securities involves substantial risk and is not suitable for all investors. The information herein is not a recommendation to trade nor investment research or an offer to buy or sell any derivative or security. It does not take into account your particular investment objectives, financial situation or needs and does not create a binding obligation on any of the StoneX group of companies to enter into any transaction with you. You are advised to perform an independent investigation of any transaction to determine whether any transaction is suitable for you. No part of this material may be copied, photocopied or duplicated in any form by any means or redistributed without the prior written consent of StoneX Group Inc.

© 2023 StoneX Group Inc. All Rights Reserved

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