Issue 106: Predicting Every Recession in the Last 40 Years (except 1) - Masters in Trading Digest

Predicting Every Recession in the Last 40 Years (except 1)

The most dependable stock market predictor of the last 40 years is the fluctuating shape of the U.S Treasury Yield Curve. According to Nicholas Burgess of Oxford University, the yield curve has got a recession forecast wrong just once in the past 40 years.

This powerful indicator tells traders when it’s time to protect their investment accounts, and if history is any guide – you best listen.

The Most Dependable Futures Trading Strategy

Are you familiar with relative value trading?

If you’re a trader that struggles with picking a stock (or future contracts) direction, you may want to consider an alternative trading strategy, referred to as relative value trading. Instead of strictly speculating on direction, the yield curve offers a great opportunity for a risk-controlled relative value trade.

Relative value trading is a different style than many retail traders have been taught. Most traders I meet use some version of Technical Analysis to speculate on the direction of Futures Contracts, Stocks, ETFs, etc.

However, that style never made sense to me for a career; it made me feel more like a gambler than a professional trader. My trading style utilizes an approach referred to as relationship trading, pair trading, or sometimes referred to as ‘delta neutral trading'. All these expressions mean the same general thing.

How Does Relative Value Trading Work?

Instead of looking at trades (or investments) in isolation, a relative value trader searches for highly correlated products that have experienced a change or breakdown in their relationship.

For example, if a major hedge fund buys a large amount of 10-year futures contracts, the 10-year future contract will most likely become ‘expensive’ relative to the other futures contracts trading on the yield curve.

The futures market is driven by supply and demand so just because the 10-year future contract goes higher (in this example) that does not mean the other futures contracts on the yield curve immediately go higher as well.

I teach traders to easily spot these inefficiencies and potentially capitalize on the breakdown and subsequent realigning of the relationships.

Bonds are an excellent trade for those who look at relationships over outright market direction because the various bond products along the yield curve are highly correlated. And because of that correlation, it’s probably highly unlikely that the 10-year and 5-year future trade in completely different directions for a sustained period of time.

To apply thought to something broader, whenever we trade (or invest) anything, shouldn’t we be simultaneously considering the value of the opportunity relative to something else?

Here’s an analogy – let us use the example of real estate.

Suppose we were searching for a home in New York City, instead of determining whether we were getting a fair price by only looking at our home's price. In that case, we might value our property relative to other similar properties nearby. Right?

We obviously would not value NYC real estate against the Northern Woods of Wisconsin property. And if we did, we would wrongly conclude that Wisconsin is inexpensive and NYC is expensive.

Whenever we invest or spend money, we instinctively check pricing against other comparable assets. Think of the process you went through when you bought your phone or even your phone case. I’m guessing there was relative thinking that found its way into your decision.

Now, let’s get back to Bond Futures.

To trade Bond Futures with a relative value approach, we want to value any point on the yield curve against neighboring contracts on the yield curve.

Opportunities present themselves when those relationships break down on either an intraday or longer period of time.

These examples barely break the surface, but when we learn to properly value Bond Futures, we’re able to make ‘black and white,’ rule-based decisions that put us in trades where we are long the cheaper instrument and short the expensive instrument…

It is important to trade markets that are ‘in play,’ and with the Fed raising interest rates, Bond futures are absolutely ‘in play’.

Interested in learning more?

This Saturday, I will be holding a webinar at 11:00 AM EST. This webinar will serve as your Introduction to Relative Value Trading.

AMC Falls on Bankruptcy Concerns

This trade was shared in our Discord options community, and it's one of my favorite types of options trades.

Trade Idea: AMC stock is in free fall so this just might be a good time to buy some out-of-the-money calls so we risk a bit, to potentially make a bunch.

Notice below, on our Volatility Visualizer tool, how AMC trades down to its lower expected move band? Because of the mechanics of options, we would expect long put holders to buy stock to lock in their profits around the expected move levels.

This would cause the stock to trade higher.

Now if we look at the option tree below, I like buying those $.77 calls on the 12 strike in AMC Sep 22 Options.

The plan is to enter the trade and wait… (traders who buy 10 for $.77 are risking $770, you can never lose more).

If/When AMC trades higher, the next part of the plan would be to sell higher strike calls for $.77 or more. If we can do that… the new trade would look like this:

  • Long 10 Calls from 12 strike: $.77 ($770 risk)
  • Short 10 calls from 22 strike: perfect plan is to sell when $.77. ($770 credit)

If we get this trade on, the risk would be $0.00, and the reward could be as much as $10,000.

Lastly, this is low risk, high reward. We have 23 days to potentially make a bunch of money; that’s a scenario I look forward to.

We can't sell the 22 strike for $.77 right now, but the trade is betting on an AMC bounce, which would allow those 22 strike calls to catch a bid and trade higher. Let’s see what happens, remember though – worst case scenario this trades stinks, and we lose $770. But if we’re right, we make $10k!

That’s my kinda trade.

Masters in Trading Digest - Issue 106

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FINAL THOUGHTS

WHAT TO EXPECT IN THE NEXT MIT DIGEST

The next issue will be released on Friday.

Don't forget on Saturday, I will be holding a webinar at 11:00 AM EST. This webinar will serve as your Introduction to Relative Value Trading.

The Volatility Visualizer has been a life-saving trading tool in the face of rising interest rates, spiking inflation, and market volatility.  Watch this 7 Video Series to See How the Volatility Visualizer can help you find high-probability trades.

Until then, trade smart and always manage your tail risk.

Thanks for reading,
Jonathan Rose

P.S. This 13 minute video will take your Options Trading to the next level. Watch Now >>>

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