I was reading a blog entry by “Macro-Man” (http://macro-man.blogspot.com/2009/04/whats-up-with-yen-vols-other-than-yen.html) who noticed that despite the Yen being super strong, Yen volatility was relatively flat over the past few weeks:
Because equity traders watch the yen, when volatility is coming off of the yen market, the appetite for risk is increasing, and the equity markets should mirror this yen spike. He postulated that this could be because the equity markets are stronger than we think they are, and that it might be a sign to start investing in equities.
I decided to test this out. How do the equity markets do when the Yen is rallying and the volatility is flat? There are several variables: how many weeks to look back, what returns to look for (jpy .weekReturn()), the maximum increase of the 2-month implied volatility over those weeks (usdjpyv2m.weekreturn()), and how many days to hold the equities. SPX was used as a representative for equity markets.
Here is the simple Strategy I created, which looks for the Yen to grow 3% in the past 4 weeks, while the 2-month volatility hasn’t increased in that time. It holds SPX starting the next day’s open for 10 trading days after the trigger, and also has a 5% trailing stop loss.
The strategy did pretty well since 1996 (the first point we have for 2 month volatility), with a Sharpe ratio of 1.75 and annualized return of 56.8% in 20 trades over 13+ years. But it has been relatively flat over the past 5 years, with only several trades being triggered during that time.
I then used Twiddle to help optimize the four parameters, and see how effective the strategy is in general. The statistics I looked at were Sharpe ratio and number of trades over the same 13+ year time period.
Looking at the two tables above, Sharpe ratios are strong across the board for 3 and 4 week look-back windows. There are several spots with a high Sharpe ratio and a high number of trades, of which I chose a 4 week window, 5 day holding period, min. 4% return on Yen, and max 1% increase in volatility.
The strategy did very well, with a Sharpe ratio of 3.53 and only 3 losing trades over the time period. It also managed to make profitable trades in the last year, despite being flat for almost 4 years before that:
We could also take this further and try the strategy on other equity Indices, or even use our InstrumentExplorer to try to find sub-groups of our equity indices that perform the best during these times.