Today, volatility remains a hot topic. Being able to capitalise on returns despite the market conditions is an attractive feature, and given the abundance of strategies to trade vol it is unsurprising it has become an asset class in of itself.

In the first part of the volatility trading series will introduce the concepts underlying volatility, what we need to look at when thinking of strategies and the technical details.

The second part will focus on implementing these fundamentals through different combinations to take a position in the market based on your views. We will look at some scenarios to see how these strategies may be used.

What is Volatility?

Volatility is a measure of dispersion, and how large fluctuations are in market prices over a period of time

We are used to seeing swings in the price of stocks and securities. These swings are quantified by volatility. If there is a period of stable growth or decline, volatility will be low. If stock price fluctuates 10% each day, there will be high volatility.

What volatility trading does is to take a position and view on how much prices will fluctuate, rather than the prices themselves.

To make this clearer, if I think that the swings in price of a security will increase in the next week, I may take a position where I believe volatility will rise. This is called going long volatility. I may not have a view on whether the stock price will rise or fall, but that it will fluctuate, in any direction.

Long Vol - a view that volatility will increase, and so I ‘buy’ volatility now while it is low

And vice versa, if I believe a particularly stable period is coming ahead, I may think volatility will fall, in which case I would want to be short volatility. The price of the stock may rise steadily or fall steadily, but the volatility will fall.

Short Vol - a view that volatility will decrease, and so I ‘sell’ volatility now while it is high

These concepts are the same as your typical ‘Buy Low Sell High’ strategy. Think of volatility itself as the asset. When I think volatility will increase, I want to buy it while it is low and wait to sell when it has increased and is high.

Volatility and Options

There is a very strong relation between volatility and options pricing. Alongside the maturity date, strike price, underlying price and interest rate, volatility is an input into the Black-Scholes Option Pricing model.

Of all of these, volatility is special. Volatility at inception of the option contract is unknown for the lifetime of the option. The interest rate is assumed to be constant, hence that along with maturity and strike are all known. The underlying price is determined directly in the market.

But volatility is unknown. That is realised volatility. We only known realised volatility once it is, well, realised. Therefore, we need another measure to be able to determine what the volatility of the underlying will be for the duration of the option.

This is implied volatility.

Implied volatility is a prediction of volatility over a period of time.

Options are now very liquid contracts. We have market prices for all maturities and strike prices. This is the output of our Black-Scholes pricing model. To determine volatility, we rearrange the equation to solve for volatility given the prevailing market prices of options.

We essentially turn implied volatility into an output instead of an input.

Constantly using market prices to determine the level of implied volatility gives us an indication of market sentiment for volatility, which can be used to then price exotic options which are not listed on exchanges and need manual modelling.

Calls and Puts

Our vanilla option contracts are calls and puts. Calls give us the right to buy an asset, and puts the right to sell. They can be used for a directional view or a hedging trade (to offset any large movements from a previous trade).

There is a strong transmission mechanism between volatility and the price/value of call options and put options:

This is because when there is higher volatility of prices, there is a greater chance that an OTM call or put will finish ITM at expiration. This is because prices can fluctuate higher to push the underlying price above the strike (for a call) or below the strike (for a put).

Using Calls and Puts to Trade Volatility

To demonstrate the most simple volatility trade we can do we consider a call option:

• Our view is that volatility will increase - we want to be long volatility

• We know that when volatility is higher, the price of a call option will increase, all else equal

• Therefore, we want to long a call option to take advantage of the future price rise

• A long call is a long volatility strategy

Demonstrating this further, let’s suppose the current price of an OTM vanilla call option expiring in 3 months is $1.50. I believe in the next 2 months, volatility will increase. I will expect the call price to increase, so I buy the OTM call for $1.50. 2 months later, volatility has risen and the same call now trades at $2.05. We can sell the OTM call and make $0.55 profit.

A similar strategy can be placed with puts. Since puts are also positive correlated with volatility, if we want to long volatility we can also buy a put option. We sell this before expiration to profit on capital gain.

If we instead believe volatility will fall, and we want to short volatility, we put on the opposite trade. We can either sell a call option (overwrite) or sell a put option. The price of both these contracts should decrease, and hence a trade to sell the contracts and buy them later (short) will profit.

Calendar Timing with Options

Since options are traded with an array of maturity dates, we can use this to our advantage. We introduce calendar timing now, and will explore calendar spreads in our next article.

Let’s suppose in 14 days we have a FOMC meeting, which is likely to generate high volatility in the market 2 days either side of the date. We can use call and put options to trade off of this:

• We want to be long vol to capitalise from the high volatility of the event

• We want to be short vol until 12 days from now

• We need 2 option contracts

  • One long vol option (either long put or long call)

  • One short vol option (either short put or short call)

• We want the maturity of the short vol contract to be 11 days from now

• We want the maturity of the long vol contract to be 16 days from now

What this will mean is that until 11 days, our short-vol strategy will benefit. This is just before the start of the higher-vol period due to the FOMC. From 12 days, we then only have the long-vol strategy. This will gain from the heightened vol.

This strategy could have been implemented by initially just the short-vol strategy, then on day 12 just a long-vol strategy. However, initialising both from the start provides a natural hedge. If there is high vol 10 days from now, a short-vol only strategy will erode your earnings, but with the long-vol in place as well, we reduce the downside effect through a hedge.

We hope that the differences in profit made outweighs the loss from the hedged trade, to gain overall.

Volatility Smile

An underlying asset has multiple options for different strike prices and different maturity dates. Across these options, the implied volatility of each differs. If we plot the implied volatility against strike price, and hold the maturity date constant for all the contracts, we obtain the volatility smile, appropriately named due to its smile shape.

This curve tells us that for low strike options (OTM puts - as underlying price > strike) and for high strike options (OTM calls - as underlying price < strike), the volatility is higher than for an equivalent ATM option. This means there is higher demand for OTM puts and OTM calls, and so the market is pricing in the possibility of extreme events.

Vix

The VIX is dubbed the ‘fear’ indicator, for it represents market sentiment and VERY short-term volatility based off of the SP500 index. It is generally a good measure of sentiment as seen with highs in 2008 and 2020.

We can trade volatility directly using the VIX itself. Futures on the VIX may be bought if we are long-vol, and sold if we are short-vol. Equally, we can buy options on the VIX depending on our strategy. We will explore some more advanced level strategies in the next series.

However, there are some notes to beware for the VIX:

• It is a gauge of IMPLIED volatility. Realised volatility may be very different. We can trade off of the spread between the two, however this is hard. There lies a fair value gap between the VIX and realised vol, because implied vol trades at a premium.

• VIX is very short-term. Short-term movements in VIX may not align with long-term expectations and hence there is a challenge in the timing of trades.

• The VIX itself is very volatile, and the volatility of volatility is a complex measurement to obtain. We have the VVIX index, which tracks the vol of VIX, however this itself is NOT the expected volatility of VIX due to it being calculated using the VIX formula itself.

Next…

We will utilise the concepts from volatility trading to scenario analysis. While abstract now, they will fit in together through the various strategies we can employ with options to produce investment decisions based on individual views.

The reason for the production cuts are evidently to boost revenue for oil-exporting countries. Oil prices have been low for several months, due to high global supply and slow demand recovery. Cuts should support prices.

6 June, 2023

Early June was the date for the July cut to be announced. This was a cut of 1m barrels per day. The economic theory underlying production cuts is that there is excess demand relative to supply, and hence prices must rise all else equal.

The key market reactions:

• Market response was muted in the physical market

Physical Market - real market for transfer and delivery of physical barrels of crude oil and refined petroleum products.

We should expect there to be an impact on the short-term physical market relative to the long-term physical market. We can consider this as a spread (difference between two prices) and see how the spread changed. A contract to trade this is the Dated Brent Calendar Spread.

Dated Brent Calendar Spread - the difference between two Brent crude oil contracts with different delivery months.

While still part of the physical market, Dated Brent contracts are specified for delivery of Brent Crude Oil (from the North Sea) in particular months. We expect the price of nearer months to be higher than distant months, hence the market to be further backwardated.

Backwardation - when near-month contracts trading higher than later-month contracts. The future curve is downward sloping, as prices converge at maturity.

Following the production cut, the July-August spread was 7 cents more backwardated from the previous week, below previous levels seen in April cuts.

• Mild tightening of financial markets

Financial Market - market serving to provide financial instruments and derivatives linked to oil prices, but not the physical good itself.

Brent futures tightening father into backwardation from 86 cents to $1.20 from the previous week.

Neither market delivered significant price rises, and this is due to external economic factors contributing to market sentiment. While production cuts raise prices, decreasing demand pressure reduce them:

1. Slow demand recovery from China

2. Major G10 economies and oil-importing countries suffering from recessionary fears, or slow growth

3. Strong oil supply from the US in the face of Russian sanctions

All contributed to lower prices, and the relatively muted reaction in June.

3 July, 2023

Announcement of production cuts to continue into August 2023.

Markets responded similarly and were further backwardated. This cut came at a slight shock to markets:

• Brent Crude Futures rose 43 cents (0.62%) in a couple hours. Brent Crude rose 0.8% on the day.

• Similar reaction to WTI oil, which rose 1.1% on the day.

In July, particular towards the end Brent oil prices reached highs of $85.39. This was in part due to the sustained cuts from OPEC+, but also recovery of growth in China and Western economies, as well as some alleviation of recessionary fears. The FED stated that their in-house economists had determined the US was not facing recessionary fears anymore. These both contributed to stronger price support for oil and a move to a less-backwardated market.

1 August, 2023

1st August, 2023 saw a surprise shock to all global markets. Fitch rating agency downgraded their verdict on the US Economy from the top level of AAA to AA+. This came with significant sell-off in equity markets and rise in yields, with the 10-year Treasury bond up 2bps.

It is therefore not surprising the oil market was hit. Brent saw its largest one-day decline in over a month, down 2%, and WTI fell 2.3%. Even in spite of low inventories, signalling high demand, and theoretically higher prices, a macro sentiment of lower confidence was the stronger catalyst.

Looking Ahead and Estimations

There is a strong sentiment for an extension of cuts into September 2023 making it 3 consecutive months of the 1m barrel/day cut.

We provide our thoughts on what lies ahead for the oil/commodities market due to this:

1. Immediate rise in Dated Brent calendar spreads for October-November and November-December

   1. Driven by rise in physical market Dated Brent due to oil cuts

2. Volatile environment for sentiment given healthier economic growth in the US and EU, however poor due to rating downgrade. Slowdown in demand stronger incentive in near-term. Less backwardated oil Futures contracts.

3. Crack spreads fall

   Crack Spread - difference in price between a barrel of crude oil and the petroleum products refined from it. Industry-specific profit margin for refineries.

   The US Energy Information Administration demonstrated on 2 August, 2023 that between 9 June, 2023 and 14 July, 2024 regional inventories for distillate fuel oil (diesel) actually increased by 18%. More refinery activity has increased inventories. Much of this refined product is shipped to the East Coast from Midwest or to the Gulf. However, there is scheduled maintenance until September 2023 on the Illinois River, connecting Lake Michigan to the Mississippi.

   As oil cuts have raised benchmark prices, crack spreads have fallen, as they are measured by subtracting benchmark prices from refined distillates. The inability to ship as much refined product and build-up of inventory has meant crack spreads have begun to fall. We expect the refinery margins to continue to fall into September, and until the maintenance leads to a full-reopening. We believe crack spreads will fall.

The oil cuts have been in an attempt to lift prices, and as seen in July, succeeded to an extent. Poor sentiment to do with the US Economy, dampened demand outlook, and we believe this will persist for the near-future. However, sustained production cuts along with continued economic growth in the EU and USA will support prices throughout September and thereafter.

In this, we looked at a simple Moving Average crossover strategy, aimed at capturing momentum swings, which would be reflected through a 20-EMA and 50-EMA overlap. We categorised this as a trend-following strategy, and today we look at another strategy of this class.

Fibonacci Retracement Levels

As explained in the previous article, a trend-following strategy believes there is a particular price movement which it believes will persist for the near future.

You may have come across Fibonacci in a Maths lesson, learning about the sequence of numbers formed by adding the previous 2 together. In the context of trading, we use Fibonacci Retracement levels, which are derived from this sequence:

Retracement levels are calculated as follows:

21/21 = 100%
21/34 = 61.8%
21/55 = 38.2%
21/89 = 23.6%

Although 50% is not technically a Fibonacci Retracement level, we often include it in a trading concept because it provides a useful level as we will see. We can continue this pattern and retrieve more granular levels, however using these retracement levels are the most common:

0%, 23.6%, 38.3%, 50%, 61.8%, 100%

So what is the purpose of these numbers? They are useful in technical analysis for defining our support and resistance levels:

These are not clearly marked labels on a price graph, nor are they the same for each asset at each time. But what Fibonacci Retracement levels allow us to do, is narrow down the search to potential levels. The specific price levels, as % between two chosen prices, may be potential support or resistance levels, depending on the current trend.

It is more of a psychological level than anything. If so many traders are aware of the Fibonacci levels, and that they may be a turning point for price, if price approaches these levels, traders will look to enact buy or sell signals due to a pre-conditioned mindset. It is also the reason we use 50% as a level; because as a midpoint it is a psychological indicator for people. It is not a hard-and-fast rule that prices must halt at the Fib levels, but since so many traders expect it will, it very often translates into reality. The expectation itself leads to a self-fulfilling outcome.

Fibonacci Breakout Strategy

Turning our attention now to our strategy and how we can use the Fibonacci tools to our advantage. When price reaches a Fib level, there are one of 2 possible outcomes:

1. Prices continue in the trend they were before hitting the level

2. Prices reverse the trend

Our strategy focuses on the first. We believe in the momentum of the asset.

To determine our points of entry, we rely on the Fib levels. We can therefore generate both BUY signals and SELL signals:

1. A BUY signal is generated when price breaks through the resistance level to continue the uptrend. More specifically, a BUY signal is generated when the last closing price is above the highest resistance level.

2. A SELL signal is generated when price breaks through the support level to continue the downtrend. More specifically, a SELL signal is generated when the last closing price is below the lowest support level.

These both define prices where we have broken the support/resistance levels and do not expect a reversal anymore. To solidify the signals, we also impose another rule: both BUY and SELL signals are only sent if the short-term moving average of volume is greater than the long-term moving average of volume.

This ensures there is enough liquidity to continue the uptrend. If we see a fall in volume, it indicates unwillingness to buy or sell, and so we should not expect significant price movements, hence this rule ensures we can continue the trend.

Strategy Parameters

Already we can see our strategy is more advanced than our first. We are not only calculating support and resistance levels, but implementing them along with a volume rule. The aggregation of multiple indicators usually provides a more assured reason to buy or sell, rather than just one. However, using too many indicators may be too restrictive or potentially overfitting the model.

To describe exhaustively the components of the strategy we initialise several parameters as follows:

• Daily Lookback = 30

  • Number of past days’ data to use when calculating Fibonacci Retracement levels

• Frequency = 5mins

  • This is how often we call on data to update our Fib levels and any new trading signals

• Stop Loss = 7.5%

• Margin = 20%

• Short SMA = 20

  • Used to calculate short-term moving average of volume

• Long SMA = 50

  • Used to calculate long-term moving average of volume

The strategy operates with these parameters. Before market open, it calculates whether there is sufficient capital. Before market close, it squares off all our positions, so we do not have any pending trades or open trades at the end of the day. Currently we have commission costs and slippage costs set to 0 for simplicity.

Results: SPY

First, we test the strategy against the SPY index.

Over a 2-year backtest, we notice that our strategy returned 21.7% relative to the SPY return of 5.7%. A volatile period means that our annual volatility was high around 25%, and this is also reflected in a Sharpe ratio of 0.51. Although returns were strong, there is still downside risk as seen around May/June 2022. This is partly reflective of wider market conditions, and we do see the breakout strategy performing well towards 2023, in spite of some SPY lagged performance.

This strategy did manage to generate an alpha of 0.08. This represents the excess return above a benchmark. A strategy can still generate a positive return but have a negative alpha, if it did not beat the benchmark, however a positive alpha (although small) indicates the breakout strategy did succeed over this timeframe.

There are many simplifications made within the strategy that boost but also hinder performance, such as 0 commission, 0 slippage, 20% margin, fixed lot size of 4000, fixed stop-loss of 7.5%.

Some adjustments may be made to the stop-loss to add a trailing element and also a dynamic position sizing element to enhance performance, however this will be balanced out somewhat by the introduction of commission and slippage costs. Implementing these will be the goal of future strategies, as we improve the precision and reproducibility to a live trading environment.

However, for now the aim is to introduce different styles of strategy which may work or not on various markets, and try to generate some alpha and return, which this strategy was able to do.

But after building a strategy, we want to see whether it can be used in different contexts. For after all, a mistake would be to build a strategy for a particular situation. This is what overfitting is. To modify a strategy and fine-tune it to work for a specific asset for a specific period of time may well have generated returns, but it is not efficient in the sense we cannot employ it across markets. Building a model and strategy based on an idea, fundamental or technical, which can then be fine-tuned based on specific market characteristics (such as lot-sizes or liquidity differences) is a stronger approach.

But, building a strategy fit for multiple markets is easier said than done.

Results: NIFTY/BANKNIFTY

NIFTY is the NSE’s equivalent of the SPY. It tracks the top 50 most liquid companies on the Indian exchange, and BANKNIFTY, as you may have guessed, represents the top 12 most liquid banking stocks in India.

For demonstration purposes, we test the same strategy with the same parameters on these indices, with a modified lot-size, accounting for price differentials. We also test it for the same period, to keep everything consistent.

Now, we notice a few things:

• Overall, the strategy returned 22.6%, which although is higher in absolute terms than the SPY strategy, it ended closer to the NIFTY benchmark, on which a buy-and-hold strategy would have returned 22.2%. This suggests that the performance relative to the benchmark was not as strong.

• Sharpe ratio was 0.5. This is similar to the SPY strategy, indicating some consistency.

• What is evident in this price graph especially, is the volatility of returns. Compared to the benchmark, our strategy shows higher highs but also lower lows. When NIFTY crashes, our strategy is expected to fall, but the drawdown we see (difference between a local peak and trough) is much larger than the benchmark’s drawdown. In addition, when NIFTY rallies, our strategy outperforms it significantly.

Overall this volatility is reflective in the alpha, and overall we generated a -0.02 alpha, and much higher beta (indicative of volatility) of 1.44 vs 1.05 for SPY. The alpha is interesting and confusing. We beat the benchmark at the end, but still generated a negative alpha. However, this is not uncommon. What this means is there was a spike at the end, in which our strategy performed well to beat the benchmark, but over the period, on average we were on par or slightly below.

This is likely driven by the sharp drops, muting the positive effects of the strategy.

Overall, we see that the strategy did generate positive returns, positive alpha for the SPY and on-par alpha for NIFTY. There are merits with the strategy, and an improvement to the parameterisation may lead to prevention of the large volatility we see, to generate a more stable time-series and consistency in returns.

Interesting Earnings

Let’s look at 2 companies earnings in particular: Citadel Securities and Meta.

• Citadel Securities

As a leading market maker focusing on quant-strategies, Citadel has not been a company out of the news, with record revenues from trading activities dominating headlines for the past 14 quarters, bringing over $1bn in each.

It was therefore a shock to investors that Citadel Securities reported a fall in revenue of 29% in Q2 2023, compared to Q2 2022. In the first half of 2023, Citadel Securities has brought in (just) $2.7bn. This is a fall of 36% YoY.

Citadel’s largest source of trading revenue is through its US Equities strategy, which has suffered this quarter from a slowdown in retail activity. A large part of Citadel’s business is wholesale: executing retail investors orders from brokerages. These orders are routed to Citadel, a market-maker, for execution. Hence, much of their order flow depends on retail investors placing trade orders. Q2 saw a significant decrease in retail activity and investment, hence this translated into tangible headwinds for Citadel Securities.

There may be a weakened sentiment for high-frequency trading firms like Citadel, with some others such as Virtu reporting suffered revenues. As market activity is slowing, the impact for the remainder of 2023 may persist as seen so far. But, we do not believe this will be a significant factor, given the size of Citadel and the extremity of revenues in absolute terms. It is still generating alpha and returns: the strategies are not failing.

• Meta

Meta has seen a different story to Citadel. Meta beat analyst forecasts for revenues in Q2 2023 in the range of $32-34bn. This represents the first double-digit percentage (11%) increase in quarterly revenue since 2021 end.

This marks a significant point for Meta, with Mark Zuckerberg facing scrutiny due to sluggish growth and concerns over the course of growth for Meta. But this enforces a positive sentiment for the company. It shows reliance of Meta in the face of restructuring: over 20,000 job redundancies and flattening management.

But the most exciting prospect for Meta remains its plans for ventures into generative AI. With big-tech companies focusing on market dominance in the AI space, this is nothing Meta is shying away from. Zuckerberg stated:

We continue to see strong engagement across our apps and we have the most exciting road map I’ve seen in a while

The potential for new product launches, supported by revenue growth beating forecasts provides a strong foundation for future price growth for Meta, given the success and competitiveness of its AI product range.

Meta has recently launched several new ventures:

Threads: instagram’s answer to Twitter - a conversation app which gained 100m users in 5 days (record by a long way)

LLM - Llama 2: large language models are seen in the likes of OpenAI, and Meta released a commercial version. Plans to generate chatboxes powered by Llama

Interest Rates

The most anticipated story of this week was the FED July meeting, even surpassing earnings reports. There was an uncertainty around the decision, with some forward guidance given by hawkish members and Powell himself to enforce the inflation mandate of the FED. And indeed, the decision swayed the way of the hawks, with a 25bps hike.

US Federal Fund rates now stand at a target range of 5.25%-5.5%. This is a 22-year high.

The usual suspects were described for the reasons: controlling inflation and bring it down to 2%. Responses were relatively muted, with slight decreases in both equity markets and US Treasuries, but nothing significant.

What is interesting is that Powell stated that FED Economists no longer predict a recession for the US, however he maintained grounded on no rate cuts for 2023. There was an indication of forward guidance, with Powell not ruling out another hike in September, but not confirming either.

Markets are pricing in a rough 50-50 chance of a 25bps hike. It is a volatile environment still, and a data-driven approach is the best way to tackle the problem, taking each month individually looking at key data prints.

But, it does seem interest rates are directing inflation towards the right direction, and hence further hikes may not be needed. This is a positive insight for stocks, and for those like Citadel and Meta.

For now, the target was to create a (somewhat) successful strategy which may be deployed to a live system. We will present a breakdown of what the strategy is, how it is tested, the results of the test and how we can use it across multiple assets.

What is a systematic trading strategy?

Before we begin with the strategy itself, we must describe what a systematic strategy is:

Systematic strategies use pre-defined rules and conditions to make trading decisions (long/short). Implemented based on an algorithm ensures strategies follow the rules for the entire duration the strategy is running and eliminates emotion and bias from the process which may arise in discretionary trading.

Systematic trading focuses on the quantitative processes underlying the algorithms to deliver a consistent strategy. Intense testing and optimisation allow for these strategies to be tailored towards specific markets or products, and install discipline in the trading process.

What is our Moving Average Crossover Strategy?

There are many classes of systematic trading strategies, and our moving average crossover strategy falls under the trend-following category.

Our strategy is a variation of this, utilising Exponential Moving Averages (EMA) as its foundation. These moving average assign greater weight to more recent data points and respond to price changes faster than simple moving averages (SMA). Depending on the time-frame of the EMA, we can analyse different characteristics:

• Short EMA (10,20): used to analyse short-term trends as sensitive to recent price movements

• Long EMA (50,100,200): used to analyse longer-term trends

We use the 20-short-EMA and the 50-long-EMA and define our crossover event as when the two EMA overlap each other.

In general, in an uptrend, prices tend to move higher over time, reaching higher highs and higher lows. The short-EMA will be more responsive, and adjust to upward price movement faster. This means the short-EMA will be above the slow-moving long-EMA.

Conversely, in a downtrend, prices move lower over time, reaching lower highs and lower lows. By the same logic, the short-EMA will be below the slow-moving long-EMA.

This is the fundamental strategy we are testing today; it is a simple one to start with. More complexities and technical indicators can be added to accompany this one, but sticking with one can isolate the effects of the EMA.

Implementing our strategy

Now we have defined the conditions for entry, however with a systematic strategy there are some further metrics we must tell our algorithm.

For a beginner strategy, we have set a fixed contract size of 1000 shares for each trade initiated. In later strategies we demonstrate how we can create dynamic position sizes depending on equal equity allocation or weighted shares.

An interesting addition we have made to the strategy is to add a lag between successive trades. We want to wait 10 bar lengths (depends on individual bar timeframe) before entering a new position, so that we are not buying and selling too much if there is multiple crossover of the EMAs in a short space of time. This will help bring down transaction costs in a live setting.

We have set a trailing stop-loss to manage the risk of our trades. This is set at 2%, meaning if the trading price falls below (rises above) 2% of the current close price for the long (short) trade, we automatically exit our position. This is to limit downside risk from trading.

To keep things simple for now, we have set commission costs as 0%. We require margins of 10% for both long and short strategies. In practice, the short-margin is typically larger, and our margin requirements may be larger based on individual brokers.

We are testing the strategy over an 8-year period:

Results

The output of this strategy is essentially a custom indicator. This is used to implement trade signals on any underlying asset we want. This is the versatility of systematic strategies.

We explore this strategy on the SPX index in detail:

We see a snapshot of the overlay of the strategy on the SPX daily chart for end of 2022 and 2023 (so-far). We see signals where there is a crossover of our EMA curves and either the long or short orders on the graph.

• Total return: 23.99%

• Average historical benchmark (SPX) return: 18%

• Sharpe ratio: 0.038

• Percent profitable: 43.33%

• Average time trades open for: 4 days

Here are just a summary of some of the statistics from our backtests. While we see that overall return has beaten the long-term S&P historical average by 6%, we note some downsides to the model which suggest return is not the only factor to consider.

1. We have not considered commission costs, which we will include in a later model

2. On average we have more losing trades than winning trades as winning percent is less than 50%. This means the average winning trade is larger than the average losing trade. While this is good, more losing trades is a concerning sign

3. Our sharp ratio is positive, but low. This means we are generating risk-adjusted returns above the risk-free rate benchmark, but not significantly higher. We will explore methods to increase this in future strategies

4. Our trades are on average open for 4 days. Winning trades are open for an average of 7 days. Losing trades are open for an average of 2 days. It may be worth modifying models in the future to allow for further lags before sending successive orders to allow trades to run their course before they are exited without hitting target profit levels

Below we see the equity curve for this strategy, which shows equity holdings over the testing range of the strategy (8 years). We generally look for smooth equity curves as they indicate more consistent performance over time.

Further thoughts

We have considered the daily timeframe and the SPX for this strategy. We may be able to test this against different timeframes and see whether the strategy works better on some than others. Also, we can test it on different products other than the SPX, as the versatility of this strategy means it can be applied to any asset.

GOLD - XAUUSD

We test the same strategy against the gold pair XAUUSD (gold/US$). We switch the timeframe of our bar data from daily to 3-hour bars.

The results display a 17.22% return for XAUUSD in the period 13 January, 2021 - 20 July 2023. We have to use a shorter timeframe due to the frequency of the data being higher, and so we adjust accordingly.

If we were to simply buy and hold Gold in the same time period as we traded, our return would be 6.28%. Our Sharpe ratio is higher at 0.237, and our profitable percent has seen a slight improvement at 48.19%.

Our strategy represents a 10.94% improvement on a passively managed investment

Indeed, we proceed with caution as this is again without commission fees. However, we can still see how one strategy which works for the SPX under certain circumstances can work under a different asset in different circumstances. This is the power of systematic trading.

We have seen a simple strategy, which under (very very) simplified assumptions has beaten a passive buy and hold strategy. We look to explore more systematic strategies, building on our trend-following one but deepening our insights into other classes. We can adjust the parameters, arguments, conditions and timeframes to achieve different results depending on our views and assumptions.

Systematic trading is a unique space where innovation is not only encouraged but required to develop efficient algorithms. Managing the levels of risk and reward is a tricky balancing act, but with the right practice; achievable.

This is evident from the composition at the top of the index:

1. MSFT - 12.8%
2. AAPL - 12.1%
3. NVDA - 7.3%
4. AMZN - 6.9%
5. TSLA - 4.5%
6. META - 4.4%

With the top 6 companies comprising almost 50% of the total index, an announcement on July 7, 2023 was imminent of a breach in concentration levels set by the SEC.

Constituents with weights over 4.5% cannot collectively make up over 48% of the index

The change is dubbed a “special revamp” of the Nasdaq: shares of the top tickers will be reduced and distributed to other members of the index.

Wells Fargo researchers estimate the following stocks will see their weight increase:

These are the stocks to watch on July 24, 2023. Portfolio managers holding shares of the Nasdaq-100 will be required to hold larger positions in these companies, with potential for price rises.

Front-running is the idea that high-frequency investors will be able to pick up profits on expected price differentials compared to more passive funds.

Passive funds are heavy investors in Nasdaq ETFs, with an estimated $251bn in passive mutual funds benchmarked to the NDX (Nasdaq). These passive funds may be outperformed in terms of speed by active investors.

As the share of big-tech companies falls, it is reasonable to assume the stock price will also follow suit. And the market price of companies expecting a rise in weight should rise, as portfolio managers are required to put more money towards them.

However, there has been little evidence of this price differential mounting into something substantial.

Big-tech companies are liquid giants. The amount of liquidity traded each day means that small expected price differentials have had little effect on any suggested underperformance. In fact, these companies have beaten all conventional wisdom and outperformed last week.

This speaks to the resounding confidence investors have in these tech monsters, and the “special revamp” is testament to their success.

Nevertheless, we expect some activity on market open July 24, 2023. We expect a small price in big-tech and we watch for the companies listed above, outlined by Wells Fargo.

The shift in asset allocation for portfolio managers does lead to some further thought about the makeup of indices, however there may be a silver lining in that it offers a chance for diversification. Being very tech-headed, the revamp will put some weight in alternative sectors.

So it seems the big-tech companies will brush-off any adversity. Smaller companies may improve due to the revamp. So does anyone lose? Well, it would be that $251bn passively invested in the NDX who may lose out to HFT firms grabbing up minute profits.

With rising volatility we can make use of WTI Crude Oil products in order to enter a position which we may think benefits from the volatility. We focus on the WTI Crude Oil Future products but more specifically, the Micro Futures.

What Are Micro WTI Futures?

As an overview, a future contract is an obligation to buy or sell an underlying asset at an agreed price at a pre-specified date. The fix the price in the contract, and the buy or sell order is executed at expiry of the contract.

Now, a standard future contract on WTI Crude Oil is an obligation to buy or sell WTI Crude Oil at a pre-specified price at expiry of the future. Commodity markets in general utilise future contracts heavily as investors like to lock-in prices now, for future delivery. This is both to take a view and to hedge an underlying position.

Micro contracts are smaller-sized copies of their regular contracts. The Micro WTI Crude Oil Future is 1/10th the size of the regular future, trading in 100-barrel increments. What this means is it is more efficient and cost-effective for investors to access the oil market, which should increase liquidity and allow for more trading. The micro contract allows for weekly and monthly expiry, so there is greater flexibility and precision.

Most importantly, the micro contracts require smaller margin requirements which is beneficial for investors.

Micro WTI Crude Oil Future Options

Now we have our future contracts outlined, we move on to the product we will use to position ourselves in the face of volatility in the oil market.

As we have discussed, option contracts are a type of derivative which are extremely diverse and allow for a low-risk option, due to the removal of the obligation to execute a buy/sell order at expiry.

We will use options which use the Micro WTI Crude Oil Futures as their underlying contract. Like their standard option contract these are also 1/10th of the size.

Premium

The premium of the Micro option differs slightly from the standard contract due to the multiplier differential.

The premiums are quoted in 1 cent per barrel tick increments. This means 1 tick move = $1 move.

To see this in an example:

Premium of the Micro option = $0.70

Cost of option = $0.70 * 1 * 100 barrels = $70

What Strategy Can We Implement?

Now we have our product to be used outlined. Now we just need a strategy.

As we suggested in the oil market update, it is tricky to conclude a directional move for the WTI Crude price. The major forces at play over the next few weeks will be:

• Slowing demand from new variant outbreak in China and concerns over implications for the opening of the Chinese economy. The recent outbreak facing China has been crippling and while China has suggested its Zero-Covid Policy will come to an end, the extent to which this is possible is not hopeful. Concerns over global outbreak will be in the forefront of people's mind, which may prevent the re-opening of the economy at a desired pace. Being a heavy importer of oil, there may continue to be diminishing demand of oil, which contributes to falling prices.

• US buyback of oil to replenish its Strategic Petroleum Reserve. With price of oil falling significantly YTD, and the US contributing heavily to this by depleting its Reserve below 400m barrels. If the US is looking to add to the Reserve, this means there will be less supply of oil in the market coming from this source, and so higher prices. The US suggests this will encourage domestic production, however the extent to which producers are confident enough of demand is yet to be seen.

• Rising uncertainty as we approach the peak of Winter. We are just one month into Winter and the worst may be yet to come. The rising uncertainty was seen with average CVOL levels over twice as higher than pre-Covid levels. However, we may see this rising further if there is increasing uncertainty over supply coming into the winter months. Low demand driven by these concerns of economic instability contributes to plummeting prices.

As we can see, there is no clear conclusion of whether we expect prices to increase or decrease. Therefore, the best strategy will use this idea.

Something which we can talk about, however, is volatility. While we may not be able to predict the price movement, we may be able to predict the volatility movement. All the above factors are likely to contribute to higher volatility. There is still a lot of uncertainty over demand and supply and without confidence there will likely be rises in volatility.

A 1-year graph of the CME's CVOL for WTI Crude can show the pattern of volatility this year. If we zoom in to December 2022, we can see it is below the trend line for 2022 in general for April - November. We may believe this is an inaccurate depiction of the current market climate, and given the above events actually expect the CVOL index to rise.

So our strategy is based on rising volatility, and a price movement which we are unsure of (up or down). Therefore, we can work with the Micro WTI Crude options to devise a trade.

Trade Idea

What we can implement is a strangle position. This is a combination of option contracts such that we buy a call option at a high strike price and buy a put option at a low strike price. The commonality between these two is the expiry date and the underlying asset.

The position benefits if there are large price movements in either direction from the strike price, and so it is a bet on volatility rising and a price movement in either direction, exactly the position we want to hold.

In addition, we can see the CVOL looks low at the moment, and so this idea supports an increasing CVOL index.

An ATM (at-the-money) option on the WTI Crude Oil Future currently has a strike price of $80.

We therefore choose a strangle position that is situated either side of this strike, so we need a lower strike for the put and a higher strike for the call.

The contracts we want to buy are:

1. $74 OTM Put Option with a premium of $0.77

2. $86 OTM Call Option with a premium of $0.61

Both have an expiry of February 2023 (monthly European option) and are on the WTI Crude Oil Future underlying. We want to buy OTM options so that the price moves towards one side and the profits of that leg outweigh the losses from the other leg.

Net Premium:

• $0.77 * 1 * 100 = $77

• $0.61 * 1* 100 = $61

• Net premium paid = $138

How Will I Be Profitable?

There are different cases in which the position will be profitable:

CASE 1: WTI Crude Oil = $90

: Time to expiration = 2 weeks

• The price of WTI Crude has risen, past the 6 point interval of the strangle position either side of the ATM strike

• The call option is now ITM

• An ITM option's premium will be higher than the premium of any other option, as there is a much greater chance of making a profit at expiration

• The put option is further OTM and the premium will fall

• Sell the ITM call option for a premium of $4.80 (estimation based on current ITM call option premiums)

• Sell the OTM put option for a premium of $0.13 (estimation based on current OTM put option premiums)

• Alternative was to hold the strangle position to expiry, in which case the call option would yield ($90-$86) = $4. The put option would expire OTM and will be worthless

• Net Premium Received = ($4.80 * 1 * 100) + ($0.13 * 1 * 100) = $480 + $13 = $493

• NET PROFIT = $493 - $138 = $355

CASE 2: WTI Crude Oil = $70

: Time to expiration = 2 weeks

• The price of WTI Crude has fallen, past the 6 point interval of the strangle position either side of the ATM strike

• The call option is now even more OTM

• The put option is ITM and the premium will rise

• Sell the OTM call option for a premium of $0.06 (estimation based on current OTM call option premiums)

• Sell the ITM put option for a premium of $6.43 (estimation based on current ITM put option premiums)

• Alternative was to hold the strangle position to expiry, in which case the put option would yield ($74-$70) = $4. The put option would expire OTM and will be worthless

• Net Premium Received = ($0.06 * 1 * 100) + ($6.43 * 1 * 100) = $6 + $643 = $649

• NET PROFIT = $649 - $138 = $511

The extent of profits depends on the volatility of the price movement. If the price does not move enough, then the premium paid for the position will be higher than the return and the position will result in a break-even position or a loss:

CASE 3: WTI Crude Oil = $83

: Time to expiration = 2 weeks

• The price of WTI Crude has risen, but not past the 6 point interval of the strangle position either side of the ATM strike

• The call option is still OTM

• The put option is further OTM and the premium will fall

• Sell the OTM call option for a premium of $1.08 (estimation based on current ITM call option premiums)

• Sell the OTM put option for a premium of $0.30 (estimation based on current OTM put option premiums)

• Net Premium Received = ($1.08 * 1 * 100) + ($0.30 * 1 * 100) = $108 + $30 = $138

• NET PROFIT = $138 - $138 = $0

We can see that the smaller the price movement of the WTI Crude, the less profit the strangle position makes.

However, given the market conditions, we expect there to be a rise in CVOL which will be accompanied by a fluctuation in prices either higher or lower than current. We believe the strangle position is a good entry to gain exposure to the oil market volatility.

Consequences of the Existing Monetary Policy

Japan has faced the consequences of this peculiar policy through its currency and its economic mandates. The JPY (Yen) lost almost a third of its value from the start of 2021 to October 2022. In addition its mandate to keep inflation at 2% has not been met, with headline inflation at 3.7% for October 2022. The temptation to increase its interest rates may be higher given the push and struggle remaining G7 countries have been enduring.

The JPY lost a significant amount of value due to the higher promise of interest rates for investors elsewhere, compared to Japanese bonds. The fall in demand for the Yen meant the currency depreciated against the USD, which faced strong demand particularly as a typical 'safe-haven' currency. This led to a significant surge in the USD/JPY pair.

The rapid appreciation of the Dollar and depreciation of the Yen led to the rise in the currency pair.

What's Changed Now?

On 20th December an announcement may have sounded the start of the BoJ's monetary tightening position.

The Bank stated it would let its 10-Year JGB yields fluctuate by 0.5% either direction around its 0% target. Effectively this is lifting the cap on yields from 0.25% to 0.5%.

While Governor Kuroda denied any claims of this being a shift in the monetary policy to a tightening one, nevertheless markets responded in a dramatic way to the historic and surprise decision. The target remains at 0%.

The initial and most obvious response was a rise in 10-Year yields:

The previous monetary policy led to severe liquidity shortages, as the BoJ's extended QE scheme led to amassed assets on its balance sheet. Japan is home to the second Central Bank which holds more assets on its balance sheet than its GDP, second to the Bank of Switzerland.

The loosening of the yield cap should allow for more liquidity in the market.

As seen on the USD/JPY graph above, the announcement led to a significant appreciation of the JPY, explaining the fall in the currency pair. This is due to increased liquidity for JGBs and so higher demand for Japanese Yen. At a time when the Dollar is depreciating rapidly, we see the downtrend of this currency pair exacerbated.

Further implications were seen in global bond markets, with both US Treasury yields and UK Gilt yields rising 0.11% to 3.69% and 3.6% respectively.

Impact on the Stock Market

Typically, the TOPIX (Tokyo Stock Price Index) is positively correlated with the USD/JPY pair. This means that as the pair rises, so do Japanese stocks.

The decision by the BoJ will lead to an appreciation of the Japanese Yen, as more investors demand the currency. This will mean a fall in the currency pair, and so a fall in Japanese stocks.

While the decision may allow for better liquidity management, and control over the mandate of the Japanese Central Bank, there are consequences on the stock market which are unfavourable for Japanese domestic investors.

What Can We Do With This?

The impact on inflation will translate into the economy with a lag, however we may expect the Bank of Japan to ease liquidity concerns by loosening the cap even further than a 0.5% adjustment. If we do believe this, we can invoke our short position on the USD/JPY pair again. This will be a good position to hold going into 2023 if we expect Governor Kuroda to push for a stronger approach to inflation.

Hedging exposure to the TOPIX could be done through futures. The TPDH3 futures are USD denominated futures on the TOPIX, and may be a better investment if we believe the Yen to appreciate.

This is because when a foreign currency appreciates relative to a domestic currency (Yen appreciates relative to the Dollar), then domestic-currency returns will be higher for foreign investments. Therefore an unhedged position on the TPDH3 futures will be a reasonable investment to take advantage of a falling USD/JPY pair.

The main reasons can be summarised as follows:

1. Low US crude oil inventories for this time of the year

2. OPEC+ production cuts

3. US buyback for Strategic Petroleum Reserve

4. Fall in demand from China

5. Continued uncertainty across commodity markets

1. Low US Oil Inventories

Comparing against previous years, current US crude oil inventories are lower than historically seen:

This has been a combination of supply pressures on Europe, and production cuts seen with OPEC+. The pressure on the US to fill-in the shortage has depleted reserves more than expected.

Concerns of supply headwinds have taken a hit to investor confidence, as fears over supply shortages mount.

2. OPEC+ Production Cuts

Speaking of the OPEC+ production cuts, we have seen this in ‘OPEC+’.

The surprise cut to production of 2 million barrels a day on 5 October 2022 stressed supply shortages further and led to price rises of WTI Crude and Brent Crude, as expected with lower supply increasing prices.

3. Strategic Petroleum Reserve

The US Strategic Petroleum Reserve is an emergency stockpile of petroleum, maintained by the US Department of Energy. It has up till 2020 remained relatively steady, with no need to use emergency stockpiles. However, since 2020 there has been a significant drawdown in the Reserve with the largest decline seen in 2022.

Declining almost a third of its pre-pandemic level, the Reserves were used to increase supply in the face of dwindling supplies to Europe and the global implications of the Russia-Ukraine crisis. Following the crisis, Joe Biden announced a 180 million barrel drawdown from the reserve; unprecedented levels.

The depletion in the Reserve was used as a tool by the US to keep oil prices low, as supplying more oil through the reserve would increase global supply and so reduce prices.

On 16 December 2022, an announcement was made that the US is looking to rebuild its Strategic Petroleum Reserves back up, replenishing the stockpile. This is in response to oil prices reaching lows of around $74 suggesting the need for direct price controls is less and can be eased. The move also comes to encourage domestic production of crude oil, giving producers assurance of demand.

Currently, it is set to buy 3 million barrels with deliveries due in February. It effectively puts a floor on US oil prices.

4. Demand from China

China's slowing economy is a severe concern for the demand-side of the oil market. Oil imports by China in September 2022 were down 2% YoY, and growth in China has been severely hindered due to its Zero-Covid policies. Recent surges in cases in China only raise these concerns.

Most commodities are denominated in USD and an appreciation of the Greenback tends to take a hit on commodity prices. The recent appreciation in the Dollar may be an explanation for diminishing demand, as import costs increase for oil-importing countries.

Recent signs of dollar depreciation may be a signal for a reversal of this trend we have seen, however these are just early signs as of now, and we still expect rate hikes by the FED to continue into 2023.

5. Uncertainty

Rising uncertainty over commodity markets in general can be seen with the CVOL index:

Here we seen implied volatility levels pre-pandemic were around 25%, but they have increased to around 50% in 2022. The increasing concerns are reflected with roughly 2x as much uncertainty as before.

The WTI futures curve also remain in backwardation, a situation when future prices of an underlying are less than the spot prices of the asset. This is suggestive of concerns of falling oil prices in the next couple years, which is counter-intuitive to the production cuts seen. This suggests rather than supply shortages, the bigger concern in the short-term is low demand, which is depressing prices. Concerns over recessionary periods and declining economic activity is likely driving this.

The VIX provides a good measure of the stock market's expected volatility, however it is purely based on S&P500 index options. A more comprehensive measure of volatility may be needed to provide a better market overview: exactly where CVOL comes in.

What Is It?

CVOL is the CME Group's Volatility Index, and is a global volatility benchmark which is derived from the most-traded option contracts on futures covering multiple asset classes.

A typical screen of the index can be seen, whereby the full coverage of the index is shown:

Providing real-time updates of volatility is a metric of paramount importance to investors, and so the CVOL's popularity has surged recently.

The CVOL estimates can be compared directly across asset classes, since the method of calculation is consistent across them. The estimates typically provide an estimate for the 30-day forward risk.

How Is It Calculated?

The CVOL is a variance calculation in simple terms.

Using data from a range of options with different strikes but the same expiration reveals that the price of ATM (at-the-money) options is higher than further OTM (out-of-money) options.

This is because if we take two put options with strike prices of $30 and $50, with the $50 put being ATM and the $30 put being OTM, then we should expect the price of the $50 put to be higher. The chances of the price of the underlying falling below an ATM option (the region in which the put option makes money) are greater than the chances of the price of the underlying falling below an OTM option. This is because if the price is currently $50 (ATM), then it only needs to fall $1 for the $50 put to make money, whereas it needs to fall $21 for the $30 put to make money. Therefore, the greater return for the $50 put needs to be reflected through a higher price of purchase.

The same relation can be seen with ATM and OTM call options, where higher the underlying price, the more OTM the call option is, and so the lower the option premium.

Plotting the option premium against strike price reveals an upward-sloping curve for puts, with a maximum at the strike price, and a downward-sloping curve for calls, with a maximum again at the strike price. The maximum is set since only OTM options are used.

The total area under the two curves is representative of the implied variance in this set of options.

We can segment this area into individual rectangles, with the option price as the height and distance between adjacent strike prices as the base. Aggregating this gives a measure of the total area under the curve, and hence the implied variance.

Taking the square-root gives the standard deviation, and annualising this gives a volatility measure which is representative of the price of all options with the different strike prices.

What the CVOL allows investors to do is to see the volatility curve across all option strikes, rather than just implied volatility for ATM options, and so is a popular tool for volatility calculations.

Risk measures can be classified as absolute measures and relative measures, however both aim to quantify the level of uncertainty in the outcomes of a portfolio.

1. Alpha

   Measures risk relative to a benchmark index. A positive alpha means the portfolio outperforms the benchmark, and a negative alpha means the portfolio underperforms the benchmark. It is a risk-adjusted measure, as it takes the volatility of a portfolio and compares the risk-adjusted performance to the benchmark.

2. Beta

   Beta is a relative measure of the volatility or systematic risk of a portfolio to the market or a benchmark. A beta of 1 represents a perfect match between the two, and any beta higher than 1 suggests the portfolio has higher volatility than the market. A beta of less than 1 is seen when a portfolio has lower volatility than the market.

   There are some issues with beta as a risk measure, notably it relies on historical information rather than future expectations. In addition, it is focused on fluctuations rather than absolute losses, which can be detrimental when losses are persistent however with small oscillations.

3. Standard Deviation

   Arguably one of the most widely used risk measures, this aims to measure data dispersion relative to the mean value of the dataset. This provides insights to portfolio volatility, a useful estimate for risk management. It tells us how much investment returns are deviating from the average returns.

   There are distributional issues of returns to consider which is a drawback of this measure, as it assumes all assets, portfolios and benchmarks follows the same distribution, which is a harsh restriction to make.

4. Sharpe Ratio

   This represents the risk-adjusted return of a portfolio, or in other words, how much return is earned for each unit of risk taken on. A positive ratio means that a particular assets or portfolio outperforms the risk-free asset, and if the ratio is negative it means the risk-free asset outperforms the portfolio.

   Risk-free assets are generally considered as Government bonds, due to the ability of the Central Bank to print as much money as possible (in theory) and so be able to pay all debt it owes (in the form of bonds). However, in reality Central Banks are constrained by inflationary pressures to limit printing of currency, and so there exist no true 'risk-free' asset. Government bonds serve as the best proxy.

   Again, this is subject to distributional assumptions which do not hold in reality. There is truly skewness in returns which distort the Sharpe ratio.

5. VAR

   Measures the chance of extreme loss in the value of a portfolio over a certain horizon, for a given confidence level. In other words, a 1% VAR would tell you in 1 in every 100 you expect losses below a certain cutoff (VAR).

   There are problems with manipulation of VAR, as portfolios may be broken up into the individual assets and shown to have less risk than the combined portfolio, which is misleading. In addition, this measure fails to identify losses beyond the VAR cutoff, and so cannot distinguish between a case of a loss of 1% over VAR vs a loss of 50% over VAR.

6. Treynor Ratio

   Known as the reward-to-volatility ratio. It measures the excess return obtained from taking on one extra unit of volatility. The excess return refers to return over an equivalent sized investment in a risk-free asset. Volatility in the Treynor Ratio is measured using beta. A higher ratio is more desirable.

   While a good indicator of risk, it faces some limitations, notably it is backward-looking, and also we can determine that one portfolio may be 'better' in terms of a higher Treynor Ratio, however we cannot judge by how much it is better.

One of the greatest successes of the conference was the agreement of a 'Loss and Damage Fund'. This is a historic step for climate-vulnerable developing countries who will be able to gain access to aid due to natural disasters as a consequence of climate change and global warming. How the fund will be funded and the exact makeup of it is still yet to be decided, but the progression in the agreement of the fund is a step in the right direction.

However, the meeting failed to deliver some of the essential elements people desired, notably a committed shift away from fossil-fuels. While the events in Russia and Ukraine of 2022 and the resulting energy crisis suffered globally should have called for an accelerated energy transition, this was not the case. At best the language from COP26 was repeated, a step in the wrong direction especially given the unprecedented weaponisation of energy, which can be read about in ‘New Age of Warfare’.

A call for a faster phase-down failed to extend to oil and gas, the extraction and burning of which combined account for 40% of all annual greenhouse gas emission. Rather, the language emphasised a 'phase-up' of new technologies for a clean-energy-transition as opposed to a 'phase-down' of dirty fuels.

The UN Secretary-General called for technology to extend further geographically by implementing an extreme weather early-warning system that will reach every single person in the next 5 years.

While these are all significant outcomes of the COP27, the old issue remains alive and unaddressed by the conference. There is a desperate need to reduce emissions. A fund for developing nations is merely a coping tool, not a preventative solution. There still is a lot of work to do, to invest significantly in renewables and stop the use of fossil fuels. This does not mean balance it out with clean energy and new technology, but cut down the use of non-renewables.

The magic number is 1.5.

It is the line on which the future of the planet lies. Preventing that line being crossed is the single most important responsibility of everyone now to ensure that we can live sustainably and not let climate change runaway.

The arguments in favour of the ban were along the lines of supporting the price of metals and preventing distortion. The issue was that if Russian metals are still exchanged there would be distortions, given the political climate.

While Russian commodities such as oil and coal have been heavily sanctioned, metals have not been as of yet, and so justification for a ban by the LME would be weak.

Russian metal however plays a crucial role in global supply and exchange. Currently, Russia produces 6% of world aluminium, 5% of world copper and 7% of world nickel. Despite this, many traders and consumers have chosen to 'self-sanction' against these Russian metals, citing ethical motives in several cases.

There are further complications this will surface. The self-banning of consumption of Russian metals, while they are still traded on the exchange will create a stockpile within warehouses of the LME. The concern is that the price of these metals will start to incorporate the unwanted Russian products held by the exchange, and may not rationally account for the actual price of metals traded. This mismatch will undermine confidence in the LME to deliver financially 'fair' prices.

What this means for exchanges which do not involve Russian metal is that it has added a premium over the prevailing price. These premiums are a 'non-Russian' premium in some ways, as people would rather spend more on non-Russian metals. An example of this is Codelco, a Chilean mining company, which has set a premium of copper of $235 per tonne above the LME benchmark.

There have already been concerns about rising stockpiles, as seen with the surge in delivery of aluminium to LME warehouses:

Whether calls for the ban strengthen in number will depend on action on Governments, as if there is a sovereign ban on metals, it is more viable for the LME to implement a ban. However, metals are difficult to replace, and given Russia's stronghold in its supply, the LME may be hesitant to call for an outright ban. This would have far-reaching implications on top of an energy crisis. In particular, it may affect the abilities of firms to receive financing from banks if these companies are facing a shortage of metal inputs. Therefore, there are wider impacts within the financial system which make it a tedious decision.

The idea of the self-sanction is somewhat of an unofficial ban, and similar effects can be achieved, however the risks to the stockpiles are of paramount importance to the LME. At a time when it is facing scrutiny from its controversial suspension of nickel trading, it would be in the best interests of the LME to refrain from any further controversial or disruptive measures, and maintain integrity as an exchange providing accurate pricing.

However, when we delve deeper into the current climate, we see there may be other idiosyncratic factors at play.

Traditional Factors

The so-called generic factors are still much at play as ever before.

• Rising interest rates in the US means that 'hot money' flows into the US economy, as investors seek higher returns on savings. This means the demand for US dollars increases, and as a result the currency appreciates. With consecutive hikes seen by the FED recently, with no signs of cuts until July 2023 (as of 4 November 2022), we expect this trend to continue.

• However, while in the past the US has been a 'flight to safety', we believe this is less of a driving force for the appreciation this time round.

It is believed a stronger force is behind the appreciation: need of non-US investors to buy dollars to cover losses on dollar assets or reduce hedges on these assets.

Hedging the Dollar

The US undoubtedly has accumulated a significant deficit of external financial assets vs liabilities, and attracted a lot of foreign capital. As of now, about $14tn worth of dollar-denominated bonds are owned by foreigners. Around half of this forms current account surpluses of other countries.

It is reasonable to assume much of this value is hedged, to protect against currency risk (exchange rate fluctuations). Especially during such uncertain climates, hedging positions is an essential tool. The style of hedging usually involves selling the dollar and buying-back home currency at a future date.

However, since the price of bonds have fallen with rising interest rates, what this means is that there have been significant losses. This involves reducing hedges down, so buying back dollars and selling home currencies.

Estimates suggest foreign investors have bought back around $700bn due to this reason, owing to losses from dollar-denominated portfolios. This number is likely the deterministic factor driving demand for dollars and causing the appreciation.

Implications for International Imbalances

Theoretically, it is expected the imbalance in the US would be lessened through a depreciation, which would occur if foreign investors became saturated with dollar risk from holding bonds.

However, the extent to which a Treasury on a hedged basis will be saturated with US risk is minimal, since the FED can always print money to pay its obligations (meaning it will not default) and the devaluation of the US $ due to excess printing is also mitigated through the hedging component. Therefore, countries will continue to accumulate more liabilities.

Imbalances will continue to grow, and this strains the financial system as balance sheets grow. They point to financial instability, particularly such as with high debt-to-GDP metrics.

The root cause of currency appreciation is by nature made up of a complex web of factors, and the implications for which is the driving force can be essential to decide a strategy to overcome the issues. The understanding of the US-hedging mechanism is essential to see past the dollar as a 'haven' and realise the impact on international imbalances. As these keep growing, due to US-debt build up, we need to contain the dollar deficit and depreciate the currency in order to reign in the deficit.

What is a Swaption?

A swaption is evidently a merger of a 'swap' and an 'option' contract.

• An option contract is one which offers the buyer the right but not obligation to buy/sell an asset at a pre-specified price

• A swap contract is an agreement for two parties to exchange a series of cashflows for a certain period of time. Usually this involves swapping a sequence of cashflow with a fixed interest payment for one which has a floating interest payment, otherwise known as a 'fixed-floating swap'

Putting these two concepts together gives us a swaption - an option contract which gives the buyer the right but not the obligation to enter a swap contract at a pre-specified price on a pre-specified date.

These are OTC contracts, and so mutual agreement is needed for the contract to be in place.

Types of Swaptions

A deeper look into swaptions reveals a great number of technical details. To keep it simple, let's start with an overview of some swaps terminology.

'Paying' a swap always refers to paying the fixed leg of a fixed-floating swap contract. 'Receiving' a swap always refers to receiving the fixed leg of a fixed-floating swap contract.

Therefore, someone who is paying a swap originally was obliged to pay a floating interest rate, but swaps their interest payments so they now pay a fixed rate. Vice versa for a receiver of a swap.

We translate the same terminology to swaption contracts to derive the two types of swaptions:

• Payer Swaption - the buyer has the right but not obligation to enter a swap contract, where they become the fixed-leg payer and floating-leg receiver

• Receiver Swaption - the buyer has the right but not obligation to enter a swap contract, where they become the floating-leg payer and fixed-leg receiver

There is further intricacies relating to the style of a swaption, which I will briefly mention:

1. European Swaption - the buyer can only exercise the option (enter the swap) at expiration date of the swaption

2. American Swaption - the buyer can exercise the option (enter the swap) at any point of time between initiation and expiration of the swaption

3. Bermudan Swaption - the buyer can only exercise the option (enter the swap) on a pre-determined set of specific dates between initiation and expiration of the swaption

The specifics of the style are less important since European swaptions are most common for simplicity.

Why Would I Use a Swaption?

Swaptions are a useful asset for their combination of two of the most heavily traded contracts. They are helpful for two important reasons: hedging and direction.

• Directional view - allows investors to place bets

  When to use payer swaptions and when to use receiver swaptions:

  • Payer swaptions are when the buyer pays a fixed interest rate and receives a floating rate. Therefore, since only the floating rate can change, the buyer of a payer swaptions benefits when the floating rate is higher.

  • Receiver swaptions are when the buyer pays a floating interest rate and received a fixed rate. Therefore, the buyer will benefit when they pay less and so when the floating rate is lower.

  By definition between initiation and expiration of a swaption, the only interest rate that can change is the one which is linked to the floating rate, usually EURIBOR (in Europe), SONIA (in the UK) and SOFR (in the US). These are all overnight rates used to calculate the interest when rolling over payments.

• Optionality - hedging

  You may wonder why we would use a swaption instead of a standard interest-rate swap (IRS). And this leads on to the second key advantage of a swaption: optionality.

  The distinction is in the name, and it means we do not have to enter the swap if we do not want to. What this does is protect us as investors from downside risk, something which is essential in volatile economic climates, which none of us are unfamiliar with.

  Optionality means is we buy a payer swaption, and interest rates actually fall, then we do not have to exercise the contract and enter the swap, protecting us from the downside.

Pricing a Swaption

The details of pricing swaptions are indeed complicated, since they are OTC contracts, and so individually drawn.

However, we can see what factors affect the price of a swaption:

• Volatility - the higher the volatility of interest rates, the higher the premium of the swaption. This is standard option theory, as higher volatility means there is greater chance of larger interest rate movements and so a higher chance of the contract ending in-the-money at expiry. This is the idea of the Option Greek Vega.

• Time to Expiration - the longer the tenor of the swaption, the higher the premium. If the tenor is longer, this means there is more time for the interest rate to change and so for the swaption to end in-the-money at expiry. This is the idea of the Option Greek Theta.

• Strike Interest Rate - the closer the strike interest rate is to the prevailing floating interest rate, the higher the premium of the swaption. This is because there is a greater chance the interest rate will move to make the contract in-the-money, since there is only a small change needed.

Receiver Swaption Trading Strategy

Now that we have determined the conditions for which a swaption would be used, let's use it in practice.

Over the course of the past year we have seen interest rate hikes to unprecedented levels. These have come as shocks and emergency measures to inflationary issues, the consequences of which we are all seeing. However, there have been promising data releases recently hinting at inflation slowing down and the peak just around the corner. This is especially the trend seen with the US, and should be seen with the UK following a dramatic political turnover, but some stability with Jeremy Hunt's vision for the economy.

What this all means is that interest rates will continue to be hiked for the next few Central Bank meetings, as was seen with the ECB 75bps hike in their October meeting just a few days ago.

However, there is increasingly more hope of interest rates falling in 2023. With somewhat more stability this should be the case, and is a reasonable prediction supported by what is priced in for meetings mid-2023.

If we do believe interest rates could fall, from what we have learnt, the best strategy to implement would be buying a receiver swaption:

1. Allows us to take a directional view on interest rates falling, as the contract will only be exercised if the floating rate falls since the buyer is paying a floating rate

2. Allows for short-term horizons of one year, which will be a good timeframe to maintain the strategy. This will allow for inflation to peak and cool off towards the start of 2023, and so allow an appropriate response by Central Banks to take effect, accounting for lags

3. Protects against downside risk of unexpected interest rate hikes. This is an issue to be wary of even with rates as high as they are. Surprise inflation is still on the table, and further rate hikes may be seen if this becomes runaway inflation as was seen towards Q2 of 2022.

These are arguments in favour of buying the receiver swaption. There are of course downsides to swaptions, namely the premium cost of entering the contract. Due to the optionality protection, swaption premiums are higher than IRS premiums, however the value of the benefit gained is best left to be decided by the investor. However, since it is an impossible task to predict the interest rate in a weeks time, let alone a years time, the added assurance a swaption may give over an IRS is undoubtedly needed.

Batteries. Rechargeable and non-rechargeable batteries. The versatility, need and abundance of batteries makes lithium one of the most sought-after materials there is.

Lithium is used in non-rechargeable batteries for pacemakers and clocks. It is used in rechargeable batteries for phones, laptops, cameras, but most importantly electric vehicles.

Electric vehicles is where the primary source of growth for lithium is expected to come from, and it is without a doubt expectations are high.

Growth of EV - Merger

The growth of EV and the urge to get into the industry is highlighted through the recent announcement of the merger between European Lithium and Sizzle Acquisition. European Lithium is a mining start-up which claims to have the first fully-licensed European lithium mine in Wolfsberg, Austria. Sizzle Acquisition is a special purpose acquisition company; a blank-cheque company.

This so-called 'blank-cheque' type of merger will result in the formation of Critical Metal, which will have a market cap of $972m and will be listed on the Nasdaq.

The mine in Wolfsberg is expected to produce 10,500 tonnes of lithium per year from 2025, enough for 200,000 EVs.

This is an opportunity for Critical Metal, as it comes at a time when many European lithium mining companies are struggling, and have particularly become reliant on supply from China, who control over 60% of global lithium processing.

EV sales are at staggering levels, and supplies of lithium are not able to keep up. This is one of several reasons which is driving the prediction for a bullish lithium market.

1. Current Supply Shortages

The primary reason for high lithium valuation is shortages in supply.

Basic demand and supply logic tells us that when we have excess demand we expect prices to rise.

Current prices stand at record highs of upwards of $70,000 per tonne. This is over 8x the level seen at the start of 2021.

2. Future Demand/Supply Deficits

Current price highs are a sign of supply shortages. However, predictions are that deficits will kick in from around 2025. Annual growth is estimated to be over 20% for both supply and demand.

However, demand growths are expected to drive a wedge between demand and supply.

The gap between demand and supply in 2030 is estimated to be about 2 million metric tons of lithium carbonate equivalent, which is 5x larger than the total market in 2021. This points to the scale of the boom the lithium market is predicted to have.

With such colossal drives in demand, it is evident to see with the similar supply and demand logic, that prices will continue to rise.

Recommendation

We believe the lithium market is on a bullish trend. This is through a combination of 3 factors:

1. Boom in EV demand

2. Lithium supply shortages

3. Lithium demand surges

We have seen evidence of companies such as European Lithium getting ahead of the competition to take advantage of the boom as suppliers will be rewarded with lucrative prices.

We support the bullish trend argument, and are hopeful for a long-horizon position on lithium as a sustainable source of return. Therefore, we implement a buy long position on lithium, with a long-term view upwards of 3 years, as we predict the supply/demand deficit will kick in 2025. This will mean price volatility is higher around this time and so it is optimal to realise returns. However, we will re-evaluate the position given any further advancements in supply especially in Europe (the largest EV market), and also given progress of the deficit in lithium supply.

It is difficult to predict once the deficit has been passed whether lithium has much more room to rise, and so we will be wary of this, however as of now we are bullish for this market.

What is an ETF?

To understand what a Green ETF is, we first must understand what an ETF is.

An ETF is a pooled asset. What this means is it is a basket of securities, that tracks a variety of different assets. This is where the flexibility comes in. ETFs can contain investments in stocks, bonds, commodities, currencies or indices. As it can hold multiple assets, it is a diversified asset, as opposed to purchasing a single stock. The flexibility plays into the ETF's favour once again, since it can offer diversification through sectors. We can purchase an ETF focused in on a specific sector or industry, or we can purchase an ETF which covers hundreds of stock over multiple sectors.

The name itself is derived from the fact they are marketable securities (traded on an exchange) and so like a stock have a price which varies day-to-day.

To demonstrate the cost-advantage of an ETF, let us take an example. Let's say we have an ETF which contains 100 stocks from the TMT industry. We have two alternative investment strategies available to us as an investor interested in entering a position in the TMT industry. We can execute 100 separate orders and purchase each of the 100 stocks individually. Not only is this time-consuming and laborious, the price of the stocks we want to buy may change between the time it takes to buy the 1st stock and 100th stock. This is an issue we want to avoid, and hence an ETF is the alternative solution. We can purchase this 'basket' which contains the 100 stocks we want to purchase, by executing just one transaction - much more efficient.

This avoids the issue of broker commissions, as 100 transactions will mean 100 commission charges, whereas we only face 1 with an ETF transaction.

Another cost to consider is the expense ratio - the cost to operate and manage the fund. Typically, for passively-managed ETFs, this is low, and allows the investors minimal involvement if they so wish. Actively-managed ETFs come with higher costs.

Sustainable ETFs

Now after that quick run-down of ETFs, let's move on to sustainable ETFs. The mechanism is exactly the same; what's different is the actual make-up of the fund.

Typically, these funds are investing in stocks of companies who are involved in green investment projects, or support the use of sustainable technologies. The definition of 'green' is one of the most heavily debated topics, and the answer is: there is no answer!

Whether these include companies which have already made advancements in green technology and operations, or whether it's those companies looking to do so in the future is also a question the investor must ask when choosing which green ETFs to pick.

While our own definitions of sustainability differ, the specific sustainable ETFs have their own criteria for eligibility.

Are Sustainable ETFs a good investment?

Of course, for an environmentally-concerned investor, a green ETF seems like a much better choice than a standard ETF.

Where differences lie is with costs as well however. Typically, we see green ETFs as having higher expense ratios. This is due to the additional costs of fund manager's time to research and analyse whether the specific companies in the green ETFs truly adhere to the 'green' criteria for that ETF.

While ETFs have become very popular, green ETFs are still on the upward trend, but not quite there. There is less liquidity and less diversification for now. It is likely that with increasing climate concerns and spotlight focus of a clean-energy transition, these will continue to be popular assets for the future.

However, there are still concerns to do with eligibility and green-washing. Many 'green' statistics are difficult to compute to a high degree of accuracy. Companies are becoming aware more investors are looking into ESG statistics, and so there may be issues to do with exaggerated figures in the form of green-washing.

Around August 2022, the SEC proposed a 'Names Rule' and strict requirements on ESG disclosures. These were aimed and praised to eradicate greenwashing, however have received backlash for being costly for fund providers. It seems there is a lot of disagreement over how to resolve the identification problem with green ETFs, and so their progress has been hindered.

In fact, an interesting revelation has been the so-called 'anti-ESG ETFs'. An example is Constrained Capital's ESG Orphans ETF (ORFN). This launched in May 2022, and founder Mark Neuman has said:

The growing popularity of ESG meant many portfolios were underweight companies involved in arms or tobacco, which offered greater potential upside

Conclusions: ESG and Hedging Strategies

Without universal definitions, sustainable ETFs will always face criticism over the precise aims of the companies being invested in. Having said this, they offer a unique type of diversification and ease of transaction which many other products fail to provide right now. For an ESG-conscious investor, green ETFs seem a sensible method to place bets on the future profitability of ESG.

For investors who are not as ESG-minded, ETFs are one of the best tools for hedging strategies. Purchasing an ETF short can be a useful tool if an investor has built a position in several individual stocks, to protect against stock market falls. In a volatile environment, hedging positions seems more and more essential. For example, ETFs such as SPXU are shorts on the SP500, and so move inversely to the SP500 index. If an investor has purchased several stocks in the SP500 it would be wise to purchase the SPXU ETF to hedge this position, such that in the case of a crash in the SP500, while the individual long positions in the stocks will lose money, the ETF will provide a positive return as it is a short position on the SP500.

If an investor is concerned about inflation in the future. An ETF can be used to hedge against this risk as well. Generally commodities tend to rise in value with inflation, whereas stocks do not observe this pattern. Therefore, purchasing a commodity ETF when one anitcipated inflation in the future may be a safe bet to hedge inflation. The GLD ETF can be purchased in this case.

ETFs are one of the most versatile products and assets, which can be used to hedge or place bets on a particular view. The ease of transaction and volumes also contribute to the benefits of using ETFs.

Speculation suggests the sovereigns are planning a cut in oil production, in order to boost the price of oil, through basic supply and demand mechanisms. Currently, the planned cut could mount to a total of 1million barrels a day. This corresponds to more than 1% of global oil supplies.

The Opec group in general command a substantial share of the world's oil output. According to recent estimates, around 80.4% of the world's proven oil supplies are located within Opec group countries, with around 2/3 of Opec's supplies contained within the Middle East.

However, the world's largest producer of crude oil remains to be a non-Opec member country: namely the United States of America. The USA supplies around 14.5% of world crude oil, with Russia in second place at 13.1% and Saudi Arabia in third at 12.1% (all figures taken for 2021).

At a time when energy prices are being targeted and caps are being introduced to slash them, it seems unnatural to plan to increase oil prices. However, the collusive nature of Opec means it is in the best interests of the oil-producing nations to increase prices and so earn more revenue globally.

However, there may be another incentive at play. With supply chain disruptions ever apparent, and fears over the future of crude oil supply mounting, many of these countries may support a production cut for domestic protection. Keeping more oil reserves may be in the best interest of these nations as the economic climate worsens and uncertainty grows.

On announcement of news that Opec was planning a production cut, the Brent benchmark rose 3% to $87.67 per barrel. This has been a significant fall from the heights seen following the invasion of Ukraine by Russia, when the benchmark reached over $130 per barrel.

Tensions between the 3 largest oil-producing nations is evident as ever. The US has concerns over the relation between Saudi Arabia and Russia, and whether this move is an attempt to help protect Moscow from some of the sanctions it has faced. The US has used crude oil as a monetary tool to attack Russia, by halting revenues it receives from it to stop Russia funding its war. The price-cap on Russian oil has meant Russia received less revenue on the barrels it sells. But the move may worsen relations between US and other Opec sovereigns, in which case the incentive to halt supply to hold barrels is a strategic move.

The meeting on Wednesday will allow us to see the true extent of this production cut, and how the Brent benchmark will react to news upon this. Concerns over further sanctions may grow as the US looks to hurt the Russian economy further.

Current Price: $30.73

Target Price: $48.44

Stop: $24.78

Catalysts

We identify three major catalysts driving our recommendation as follows:

1. Dividends and Share Buybacks

   Comcast operates with a diverse revenue stream, with several subsidiaries such as Xfinity, Universal and Sky Studios to name a few. This has allowed for strong returns for shareholders as of Q2 2022 despite challenges facing many companies with falling revenues.

   Notably dividends in Q2 amounted to $1.2bn, with the payout ratio standing at 29.6%. Comcast stated in their forward guidance that their expected 5-year CAGR for the payout ratio is 12%, a strong position for shareholders of Comcast to be in. Earlier this year, annualised dividends per share increased 8%, and the Q2 results highlight the impact of this change. At the same time, the share buyback programme increased its authorisations, and is set to increase further. Share buybacks are a good sign for the stock price to increase, as it is reflective of a strong fundamental position the company stands on as it has the capacity to conduct this buyback.

   Both of these combined suggests Comcast is in a healthy position, and shareholders can look to benefit from holding the stock in the near future.

2. Strong Market Positioning

   By nature of the industry, most companies become natural monopolies due to the heavy set-up costs and maintenance costs required to operate a telecoms network. Indeed, Comcast's internet broadband footprint reaches 51% of American households. Traditionally there is little competition and little threat of competition due to the high barriers to entry. In particular, fixed-line internet service is received through one of two channels: cable or phone companies. Comcast sits in the cable category, and across nearly half of America, it is the provider of choice.

   And to further this, Comcast has announced global expansion into the Nordic countries in September 2022 to add more customers to its expanding base. This global expansion will be in the form of SkyShowtime, a European streaming platform, with ambitions to roll it out in 17 more European countries in 2023. This market comprises of over 90m households, and so the potential growth prospects for Comcast are promising.

   It is the diverse business range and strong market position combined that we believe will support the future growth of Comcast as a multinational conglomerate.

3. Fair Value

   Finally, we believe there is value in Comcast, which has not been priced in on a relative value basis. The average P/E ratio over the last 10 years has been 18, but currently the forward P/E ratio stands at 9.9. We believe this is reflective of a discounted share price, given the current and future performance of the company is strong.

   The stock has seen a fall over the past few months, with its 52-week low on 6 September 2022 at $35.61. However, while we note the stock fell 29.2% YTD (2022), when we compare this to a benchmark, the S&P 500 fell only 17.6% in the same period. We believe for the above reasons, and on a relative value basis, that Comcast has been skewed to the downside and has fallen more than justified by its value, and hence we believe there is potential for the stock price to rise to its fair value.

Risks

We identify a risk to Comcast's long position recommendation being the arrival of new competitors and a loss of customers. We note Comcast saw a fall of 10,000 net residential broadband consumers in Q2 2022, and this is likely due to growing competition from fixed wireless offerings by Verizon and T-Mobile. This would pose a threat to our Comcast position.

However, we do not see this as a significant risk for two reasons:

1. Despite the fall in customers, in the Q2 2022 results, Comcast adjusted EBITDA grew 10.1% Y/y, suggesting the diverse revenue stream offset the fall in customers on the broadband side. The nature of the conglomerate suggests rising competition in one field is not a significant concern, and has not affected the company.

2. Second, we note that the nature of the competition itself may not be as aggressive as currently feared. Verizon and T-Mobile are phone companies, and generally consumers prefer cable operated networks than phone. This is because it is faster, more reliable and offers customers more flexibility, all of which are highly valued.

Therefore, we do not believe the risk currently facing Comcast will amount to any significant reduction in the stock price, and so we recommend the long buy position on CMCSA.

Given the escalation in the global energy crisis, inflationary pressures persisting and US/Japan specific conditions, we are updating this recommendation to a hold position, as we explain now:

US

A survey, published on Saturday 17 September in a collaboration between economist from the Financial Times and the Initiative on Global Markets, has suggested the FED is not prepared now or in the near future to consider tighter monetary policy. The current Federal Fund Rate sits between 2.25% and 2.50%, however almost 70% of the economists believe it will peak at roughly 4%-5%. Not only is the hiking a factor, but the consensus is that the FED will keep rates hiked past 2023.

The energy crisis in Europe has indeed escalated, with Nord Stream 1 supply standing stationary at 0% capacity. Political tensions are mounting as a result, but the bigger issue on hand is the persistence of inflation which the crisis is exacerbating. With the FED and major central banks now focusing solely on inflation, it seems reasonable to assume interest rates will continue to rise, past expectations.

What this means for our USD/JPY position, is that higher interest rates will further appreciate the dollar, and so the currency pair will rise further. If the FED does hike 75bps in the next meeting, which is the current minimum estimation, we may see a slight pullback in the USD/JPY pair, which recently hit a resistance of 145. However, given the time-scale over which the hiking is predicted to last, we have further evidence to suggest the pair will break the 145 mark.

Japan

However, despite this, we do not recommend a long position. This is because speculation of a BoJ intervention has increased amongst investors. On 14 September, it was reported that the BoJ conducted a rate check, which could be pre-emptive of an intervention by the BoJ, to support the falling Yen. On news of this, the Yen rallied, with the USD/JPY pair falling 0.8%.

As mentioned in our previous article, intervention by the BoJ would be supportive of a short position for the currency pair, as market reactions implied as well. It seems the Yen has reached a severely depreciated point, where intervention is needed.

Conclusion

We are presented, therefore, with conflicting evidence for the future of the currency pair. If there is an intervention by the BoJ, we will see the short position profiting, however the FED interest rate hiking cycle is supportive of a longer timeframe. Therefore, we will most likely see a fall and then a consequent rise in the pair, however the timing is especially hard to judge given the minimal evidence of intervention. Therefore, we believe a hold position is the best option at the moment.