Many commodities have an inherent currency risk (a majority of commodities are priced globally in US dollars) for the commodity growers because the grower's expenses may be in a currency that is strengthening against the USD, but whose revenues are denominated in USD.
To hedge against this risk, growers (and speculators) can trade US dollar index (/DX) futures which protect against broader movements in the dollar against other currencies.
As a commodity trader, it’s important to remember that when you trade a product priced in dollars, you are trading the dollar index whether you realize it or not.
We ran some correlations with sugar to other products, to see these correlations, check out the last episode.
The strongest correlation that we found was a negative correlation between sugar and the US dollar index (-0.37).
The US dollar index futures contract is a leading benchmark used for the international valuation of the dollar. It also happens to be the most widely recognized and traded currency index in the world.
USDX allows traders to monitor the moves in the value of the USD relative to a basket of world currencies. USDX allows traders to hedge their portfolios against the risk of movement in the USD.
USDX (/DX) Specs:
Contract Size (leverage) - $1,000
Current Price - $97.50 *
Notional Value -$97,500 * = ($97.50 x $1,000)
Tick Size - $0.005 ($5.00/tick)
/DX is traded 21 hours a day and is open Sunday night starting at 5pm CST. It trades from 8pm-5pm. The contract months are March, June September, and December.
The 6 month correlation of sugar to the USDX is (-0.29) and the sugar to Euro FX correlation is +0.26. If we want to be long sugar, then we want to be long the dollar index as well due to the slight negative correlation. Knowing the USDX and Euro FX are also inversely correlated, we will want to sell the Euro FX contract.
We will want to notionally weight this trade since the notional values for Sugar (/SB), USDX (/DX), and Micro Euro FX (/M6E) vary so widely.
At this time, the notionals are as follows:
/SB’s notional value is $11,760
/DX’s notional value is $97,400
/M6E’s notional value is $13,700
If we want to be long sugar…
To get the notional exposure of sugar to the USDX, we’d have to buy 8 sugar contracts and sell one USDX contact. If we adjusted this trade for IV, it would take us down to about 3 sugar contracts to 1 USDX contract.
If we wanted to get smaller with this trade, we could buy 1 sugar contract and buy 1 micro Euro FX contract (because it’s inversely correlated to the dollar).
Strategies: Futures Pairs Trade
Products Discussed In This Episode: /SB, /DX, /M6E
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