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DJ EuroStoxx50 Futures Volatility Forecast (06/06/2011)

We were bullish the European market but our forecast proved correct solely in the first half of the week because over the second half the market retraced and moved sideways. In fact, futures prices opened at 2,811 rose to 2,872 but then plummeted to 2,795 on Thursday and then closed at 2,784 on Friday.

The current volatility is 1.4% (22.2% annualised) and the TGARCH plot is evidently displaying a downward sloping curve which is probably going to collapse even further over the next trading days in order to complete the mean reverting process.

Furthermore, the conditional variance, which symmetrically increased on Monday and Tuesday along with the price action, is now trying to revert towards its equilibrium point which is stable around the 0.9% area (14.2% in annual terms).

However, the interpretation is quite difficult in this case: is the drop in the conditional variance due to the sideways movement or to investor’s will to push the Index back up again? We believe the first hypothesis is the most reliable one.

The HyperVolatility team is bearish the DJ EuroStox50 futures because the conditional variance should collapse during the next trading days, accompanying an ulterior lateral movement of the price, but should augment in the second half dragging the market down into the 2,735 – 2,740 area by the next Friday.

However, should the market rise we won’t enter any positions and we will wait for the price action to stabilise because at the moment the large amount of macroeconomics data and the transitory period the economy going through are spreading a lot of irrationality amongst participants: the market is always right but that does not imply we have to agree all the time.

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