Which Financial Markets Should I Watch?

Option Posts Insights

Mar 21
markets to watch

Newer options traders often ask, “What stocks should I watch?”.

There are in fact over a 1,000 publicly traded companies on which you could keep tabs, but in this article we're going to talk about the few futures markets you should watch. 

You don't have to actually trade futures contracts, but these specific futures markets will give you a bird‘s-eye view to what is going on in the various financial markets of interest, so you won't have to monitor individual stocks as closely.

Here's a list of futures that are important to watch and each of their associated ticker symbols:

Stock Indices 

  • S&P 500 (/ES)
  • Dow Jones 30 (/YM)
  • NASDAQ (/NQ)
  • Russell 2000 (/RTY)
  • Volatility (/VX)

Interest Rates

  • 20-year Treasury Bond (/ZB)
  • 10-year Treasury Note (/ZN)

Commodities

  • Gold (/GC)
  • Crude Oil (/CL)

What are Futures  Contracts?

Futures contracts are binding contracts between the buyer and seller to transact the underlying asset at expiration.

Futures contracts and options contracts are similar in that they are derivative securities -- each derives its value from the underlying security.  For example, an option contract on Apple stock derives its value from the price of Apple stock.  The same goes for futures contracts.  A gold futures contract derives its value from the price of gold.  Additionally, both futures and options expire at a predetermined date in the future.

Futures provide a great amount of leverage, but are straight directional bets. That is why we generally don’t advise on futures in our trading strategies.  There is a lot that can be learned about futures contracts, but this is as far we'll go in this article.

Let's now explain in detail the futures contracts that we do watch.

Stock Indices

The stock market indices are baskets of stock that track the overall stock market.  You can often hear these stock market indices quoted on financial-news reports as barometers on key segments of the stock market.  Instead of having to look at hundreds of stocks to see how the overall stock market is doing, they created indices, which are aggregates or value-averages of industry-related stocks.  The different stock market indices listed represent different baskets of stocks. 

S&P 500

This index tracks the 500 largest companies in the US.  This includes companies like Apple, Caterpillar, and Procter & Gamble. The S&P 500 is a capitalization-weighted index.  This simply means that larger companies have a greater weight than smaller companies.

Dow Jones 30

This index tracks a selected 30 stocks. This index typically contains industrial stocks like GE, Unitedhealth, and Boeing. The Dow is a price-weighted index.  This means that a higher priced stock has greater weight than a lower priced stock.

NASDAQ

This index tracks all of the companies listed on the NASDAQ Exchange, primarily composed of technology-related stocks like Apple, Amazon, and Google. As for the S&P 500, this is also capitalization-weighted.

Russell 2000

This market-capitalization-weighted index tracks 2000 small-cap stocks , or companies worth less than $10 billion.

Volatility

This is not a stock index; rather, it is a direct measure of volatility in the stock market.

The stock market indices are important to keep tabs on because they directly correlate to the economic worth of actual stocks that we do trade.  Understanding whether our stocks’ indices are up or down helps to give us an idea as to whether our positions are going to make or lose money.

In general, all of these indices, aside from volatility, are highly correlated with one another. This means they generally all move in the same direction.  It is important how these indices change to gauge your overall portfolio risk.  For example, if you have positions on in a bunch of S&P 500 stocks with all the same directional bias, you essentially have a correlated risk since all the stocks in the S&P 500 generally move together.

Interest Rates 

We watch the 20-year Treasury Bonds and the 10-year Treasury Notes as determinants of federal interest rates and ultimate yield on Treasury debt, which is considered to be risk-free.

What is a little more complicated about Treasury assets is that their prices are inversely correlated with interest rates.  When you look at a quote of such a note or bond, and its price is going up, that means that the respective yield, or interest rate is going down.  Similarly, if the price of T-notes or bonds goes down, the associated yield would be rising.

The reason why interest rates are important to watch is because they affect many critical areas of a business.  Changes in market interest rates affect the cost of borrowsing money from banks, which further affects the investment decisions of many careful people.  For instance, if a rational investor owns a risky stock that pays a 2% annual dividend, but risk-free Treasuries also pay 2% in annual interest, he would surely choose swapping for the risk-free asset.

Commodities

The last type of market that we watch is commodities.  There are many commodities that are available to trade, such as silver, wheat, corn, soybeans, and natural gas.  However, the two that we watch closest are gold and crude oil.

The price of gold can measure the amount of fear or instability in the stock market.  If there is a lot of fear or uncertainty in the stock market, investors tend to move towards gold, which is almost universally seen as a store of value to keep money safe, irrespective of the behavior of currencies.

Secondly, gold is influenced by inflation.  As inflation rises, the price of gold typically will increase as well.  This is because inflation nearly always lowers the value of the dollar so investors turn to gold to maintain the purchasing power of their money.

Lastly, we watch crude oil because it affects the stock price of energy-related companies, whose profits depend on the price of crude oil.  If the price of oil goes up, these companies’ profits will also increase and vice versa. So, if we see a big reduction in the price of crude oil, we could expect an equivalent downturn in energy-related stocks.

Even if you don’t have any positions in energy stocks, it is important to watch, because energy sector is one of the largest sectors in the S&P 500.  Since the stocks in the S&P 500 are generally correlated, a big move in the energy sector correspondingly affects other sectors where you may have positions.

Summary

Summing up, watching the different markets from a high level will provide you an increased market awareness-- a useful understanding of what is going on in your ultimate market of interest.  Just as in any other field of expertise, it is important to stay up to date with the latest trends and events that are relevant to your investing goals.  Armed with this knowledge, you can make more profitable trading decisions and mitigate your portfolio risk.