carry trade calculations?

[SanMiguel]

Ok, thanks.
Were my calcs. correct because something seems off?
If I buy £10 per point of the ES (same as £1 per 0.1pts) and wanted to do a spread trade on the AUDJPY, what would be the equivalent?

£10 on the ES = £1,100 = $1,738 (at exchange rate 1.58)
that would be YEN 149,468 (at ech. rate 86)
which would be AUD 1,892 (at exch. rate 79)
which = £2.30 per pip in AUDJPY (1892/79/10)?

£10 on the ES = £1,100 = $1,738 (at exchange rate 1.58)
that would be YEN 149,468 (at ech. rate 86)
which would be EUR 1,311 (at exch. rate 114)
which = £1.15 per pip in EURJPY?

Bonds - lost on that one. If a bond is at 123 is that $123 per bond or $12,300 per bond?

Is this correct?
£10 per point on FTSE = £54,000 in real market
in yen that would be = 7,307,820 (using GBPJPY exchange rate of 135.40)
in aud$ that would be AUD$93,690 using AUDJPY exchange rate of 78
but the equivalent position in AUDJPY then = 93,690/78/100
So, we get £12 on the FTSE to £10 on the AJ ?

 

[Rhody Trader]

Is this correct?
£10 per point on FTSE = £54,000 in real market
in yen that would be = 7,307,820 (using GBPJPY exchange rate of 135.40)
in aud$ that would be AUD$93,690 using AUDJPY exchange rate of 78
but the equivalent position in AUDJPY then = 93,690/78/100
So, we get £12 on the FTSE to £10 on the AJ ?

If you're trying to trade equal values between the FTSE and AUD/JPY then you'd need the GBP/AUD rate to figure out how many AUD you'd trade. From your figures that rate would be 1.7350 (93690/54000). The JPY crosses don't matter in position size regard.

If you want to match pip/point values then you need to figure out what the equivalents are. Is 1 FTSE pt the same as 100 AUD/JPY pips? Is the ratio something else? In other words, you have to figure out what roughly equivalent moves are and match up your position sizes from that.

Then there's the question of doing a ratio based on volatility and/or correlations.

In other words, you're not talking about a simple thing here.

 

[SanMiguel]

If you're trying to trade equal values between the FTSE and AUD/JPY then you'd need the GBP/AUD rate to figure out how many AUD you'd trade. From your figures that rate would be 1.7350 (93690/54000). The JPY crosses don't matter in position size regard.

If you want to match pip/point values then you need to figure out what the equivalents are. Is 1 FTSE pt the same as 100 AUD/JPY pips? Is the ratio something else? In other words, you have to figure out what roughly equivalent moves are and match up your position sizes from that.

Then there's the question of doing a ratio based on volatility and/or correlations.

In other words, you're not talking about a simple thing here.

The problem with the ratio based on daily range is that the daily range can change.
Where the AUDJPY might normally be 140 pips, the FTSE might be 100 but on any given day, it could be drastically different.

The alternative I have is to rebase to 1 but I have no idea how to do that...

 

[SanMiguel]

Like I noted before, the AUD/JPY vs. S&P correlation is a function of both reacting to the same basic fundamentals. The carry trade, as represented by AUD/JPY, is on the rise (greater demand to borrow and convert out of the yen, higher demand for higher interest rate currencies) becomes more popular when the economic backdrop is good because it increases the prospective returns of the strategy and reduces the risks. Same with stocks.

It seems strange that the correlation would be so perfect. I ca understand the risk on, risk off process but why would that always equal the same currencies (notably EUR, AUD, JPY in these cases)?
1/ If people are putting money into AUD and the stock market at the same time the that's fair enough - AUD and the ES would move in the same direction. But the if you had say 10k, why would you put 5 into AUD and 5 into the ES, why ot just 10k into 1 of them?
2/ However, if people were borrowing yen, to convert into AUD, but then using that money to buy the ES, then that would also involve a conversion to USD at some point. So, in fact you'd expect the USDJPY to be better correlated, which it isn't.
3/ If it's using the interest of the carry to buy at leverage, you would also expect the AUD to drop against the USD as money is converted to USD but further to the point, the interest is earned daily so shouldn't there be a delayed reaction between the FX market moving up and the ES moving up as opposed to the almost instant move in the current market?
3/

 

[Rhody Trader]

It seems strange that the correlation would be so perfect.

It's not. Three times in the last year the EUR/JPY vs. S&P 500 1-month correlation has gone to zero or negative and seems to have spent about as much time below 60% as above it.

1/ If people are putting money into AUD and the stock market at the same time the that's fair enough - AUD and the ES would move in the same direction. But the if you had say 10k, why would you put 5 into AUD and 5 into the ES, why ot just 10k into 1 of them?

Who says that's not happening? Not everyone in the world is doing a carry trade.

2/ However, if people were borrowing yen, to convert into AUD, but then using that money to buy the ES, then that would also involve a conversion to USD at some point. So, in fact you'd expect the USDJPY to be better correlated, which it isn't.

Which is one of the reasons I've said it's not a JPY to AUD to ES trade.

3/ If it's using the interest of the carry to buy at leverage, you would also expect the AUD to drop against the USD as money is converted to USD but further to the point, the interest is earned daily so shouldn't there be a delayed reaction between the FX market moving up and the ES moving up as opposed to the almost instant move in the current market?

You assume that the interest is actually paid daily, which may or may not be the case. What's to say traders/investors are borrowing 1yr JPY (or longer) and putting it in 1yr AUD or EUR paper? And for that matter, what about investments that are in non-interest paying instruments, like stocks or commodities?

You have to stop thinking of the carry trade as being done the way a retail trader would do it. That's not how things work in the world of hedge funds and the big players.

 

[SanMiguel]

What's to say traders/investors are borrowing 1yr JPY (or longer) and putting it in 1yr AUD or EUR paper? And for that matter, what about investments that are in non-interest paying instruments, like stocks or commodities?

This is the AUDJPY vs ES relationship since 2006 - not perfect but very well correlated - I haven;t run it through the RSI to get exact correlation stats.
For a correlation to be that exact and the market not converting money into USD at the same time, the market must be splitting investments perfectly equally between AUD and the ES. If any money were split into other instruments (commods, bonds, etc.) then you'd have thought one of the correlated instruments would move in a different direction entirely.

 

[Martinghoul]

This is the AUDJPY vs ES relationship since 2006 - not perfect but very well correlated - I haven;t run it through the RSI to get exact correlation stats.
For a correlation to be that exact and the market not converting money into USD at the same time, the market must be splitting investments perfectly equally between AUD and the ES. If any money were split into other instruments (commods, bonds, etc.) then you'd have thought one of the correlated instruments would move in a different direction entirely.

This is very warped logic, IMHO...

 

[SanMiguel]

This is very warped logic, IMHO...

In what way though? :smart:
If I'm a trader and investor and I think "right, it;s risk on time, what can I buy. Oh I'll take some of those AUD, and some of those ES contracts please".
I'd have to repeat that exact same proprtion of risk assets each time it was "risk on".
...or perhaps it would be buy gold (thereby pushing up gold related commods AUD, NZD) and also the ES. Of course there are many variations but ones resulting in a correlation like the attached graph for over 3 years?

 

[Martinghoul]

All I mean to say is that, to see the degree of correlation you're observing, it's certainly not necessary that there's a mechanical allocation of capital in equal parts into AUD and Spooz.

To echo what Rhody is saying (I think), imagine two completely separate communities of investors, whose investment decisions just happen to be driven by the same fundamental asset allocation rules. That's the only thing that's happening here.