Options Trading Tactics: Asset Correlation
by James Franklen
Going about options trading is not simple. You have to adopt risk-minimizing tactics when you jump in to it, all the way through to every time you are picking up trades. You would already have learned enough about how you should initiate in the binary options trading, would have got knowledge about various technical and fundamental tools and are already making trades based on all the acquired knowledge and experience.
It is amazing how many things you can apply to actual world that you study these days. Consider, for example, the students of financial analysis and financial risk management. They are taught many tools and technical stuff that is readily applied on both vanilla and binary options trading. Asset correlation is one such thing. In the books it is taught as a tactic to identify the ferocity of relation in the movement of one asset to another. Either assets can be perfectly correlated, or be totally opposite. This knowledge has trading implications, and asset correlation can be used as a tactic to obtain successful trades.
Some assets have direct correlations. For example, if German Index is going in uptrend, gold also follows that uptrend. On the other hand, if the US Dollar strengthens, the price oil rises. Reasons for existence of this correlation can be numerous and hefty, and are very complex to discuss here. However, identifying these correlations is not too complex a job. You can use asset correlation knowledge to gather evidence about viability of any prediction you are making for an asset.
Let us assume that the pair USD/EUR has a perfect direct correlation with the Oil. You can find this fact with a little ease through visual analysis. Place price charts of both the assets side-by-side in your platform. Now we assumed that the pair has direct correlation, so here you would notice that the price of both assets pretty much moves harmoniously together. If USD/EUR falls, the price of Oil also seems to fall.
So if you trade in Oil and your fundamental analysis and technical signals suggest that the price of Oil is about to rise, you can ascertain the prediction’s validity by looking at the price chart of USD/EUR. If the prediction is correct, the price of USD/EUR pair should also go up. But if the prediction is wrong, the price of USD/EUR pair would be going down and you would straight away abandon the idea of buying a call option on Oil.
The extent of correlation in asset prices not perfect in reality. It is a rare situation. However, the best example of correlation can be noted between Gold and Silver metals. This does not mean that correlations wouldn’t exist at all between other assets. It means that those correlations are weaker. For example, if a kid slaps you, the pain you get is cute. However, if your dad does it, it’s excruciating. The correlation between kid’s slap and pain, and your dad’s slap and pain is similar. But the correlation is way stronger with your dad’s slap. Therefore, you should identify these correlations and make your trades efficient and safer.