What is the Hedge Ratio? The hedge ratio is a powerful tool for predicting market behaviour, pinpointing the exact levels on an index where dynamic delta hedging will likely trigger significant buying or selling activity. It allows traders and investors to anticipate shifts in market momentum and identify where futures trading will intensify, providing a strategic edge.
The Predictive Power of Dynamic Hedging: Dynamic hedging is the process of continuously adjusting a hedge to stay neutral as market conditions change. When managing a non-linear position, such as options, with linear instruments like futures, the sensitivity to price changes (delta) shifts as the underlying asset’s value fluctuates. To maintain a balanced, zero-delta position, the hedge must be adjusted frequently. This constant recalibration is known as dynamic hedging, and it’s where the hedge ratio steps in, offering a roadmap for where these adjustments will occur across the market.
Nb. Our comment on 16/12/24
Seems like it wasn’t such a big ask keeping the FTSE zone-bound last week, making three-weeks in a row it has been collared by the boundaries 8250 and 8350.
Monday was the only day it showed some attitude, getting as high as 8372.05 and closing just a smidgen above the upper boundary.
Thereafter however, it was business as usual, with the intraday high on Tuesday of 8352.13 and the intraday low on Wednesday of 8248.42.
Thursday and Friday it hardly moved away from dead centre, being 8300.
Anyway, before we get onto this week, we have added above a little explainer above about what it is that we analyse, just to remind everyone. Of course, please feel free to share.
What has prompted us to do this now, was the news during the week about the UK listed £27bn Ashtead Group shifting their listing to the US.
Certainly, don’t blame them, in fact we probably understand better than most why. As we have said throughout this expiry, mainly due to the hedge ratio, the FTSE has been stuck in its zone, while the US has been reaching new highs. While this may be great for derivatives, it does not help your average FD, who needs their share price to reflect the true value of their company, along with all the associated finance costs.
This really is a major problem for the UK, as if these big companies are registered here, then this is where they pay tax. Hopefully, at some point, someone will actually listen to us, but we are not going to be holding our breath.
Now, far more importantly, next week.
We have eventually reached the rollover and settlement week of the mighty December expiry, the biggest of the big.
Being quite honest, after the first week of this expiry, way back on the 18th November, when the market managed to rally from 8050 (and November’s expiries zone) all the way up the December expiries zone, 8250-8350, it has been placidly stuck there much to the delight of derivatives.
So, whatever happens during this week, we very much feel as if its job done.
However, being greedy, perhaps holding in said zone until rollover Wednesday, would provide the icing on the cake. However, let’s face it, they probably have indigestion now anyway it has been such a big and rich cake.
If it does break free, then 8450 is an even tougher ratio level now, but this will depend entirely on when it is challenged.
For example, if they do manage to hold it in the zone until Wednesday then, quite frankly, nobody is going to care about Thursday or Friday.
We still have our “Santa rally” to come, although we call it the year end “bonus rally”, so plenty of time left for that, and from next week we are into the January 2025 expiry anyway.
Range: 8250 to 8350
Activity: Very poor
Type: Bullish
www.hedgeratioanalysis.com
Nb. Our comment from 09/12/24
If week two was all about the zones’ bottom boundary, 8250, for the FTSE, then last week, week three, was all about the upper boundary 8350.
In fact, only Monday ignored it. Tuesday was the most aggressive, with the index peaking at 8388.37 before finishing at 8359.41, significantly above said upper boundary.
However, thereafter the R2 ratio it found itself in was obviously too much for it and, despite trying every day to get and stay above 8350, the FTSE closed happily within its zone.
It is worth noting that every day last week the DAX notched up new all-time highs and even the CAC added about 2.7%, making the FTSE distinct lack of forward momentum stand out in stark contrast. Of course, even all three main US indices also notched up new all-time highs.
Evidently, they didn’t have to contend with all those futures selling forced out by the R2 level of dynamic delta.
Looking ahead to next week and, although it is week four, the rollover and settlement is the week after, the market is now very familiar with both of the zone boundaries by now.
It would be nice if it could manage one more week being zone-bound, or at least the bulk of it, but this will be a big ask we suspect.
The only change in the ratios, is B1 above the zone slips back to 8600. However, the ratios are actually weaker both above and below the zone, despite this being the only move.
Ordinarily, we would say the FTSE would break out of its zone at the end of the week in anticipation of going a bit wild in the final week.
However, we know the SPX is knocking on their R2 ratio door, so if they and perhaps the other record setting indices see some weakness, this might upset the FTSE’s plans.
Range: 8250 to 8350
Activity: Very poor
Type: On balance just not bearish
www.hedgeratioanalysis.com
