Correlation Between Cotton and Cocoa
Can any of the company-specific risk be diversified away by investing in both Cotton and Cocoa at the same time? Although using a correlation coefficient on its own may not help to predict future stock returns, this module helps to understand the diversifiable risk of combining Cotton and Cocoa into the same portfolio, which is an essential part of the fundamental portfolio management process.
By analyzing existing cross correlation between Cotton and Cocoa, you can compare the effects of market volatilities on Cotton and Cocoa and check how they will diversify away market risk if combined in the same portfolio for a given time horizon. You can also utilize pair trading strategies of matching a long position in Cotton with a short position of Cocoa. Check out your portfolio center. Please also check ongoing floating volatility patterns of Cotton and Cocoa.
Diversification Opportunities for Cotton and Cocoa
Significant diversification
The 3 months correlation between Cotton and Cocoa is 0.05. Overlapping area represents the amount of risk that can be diversified away by holding Cotton and Cocoa in the same portfolio, assuming nothing else is changed. The correlation between historical prices or returns on Cocoa and Cotton is a relative statistical measure of the degree to which these equity instruments tend to move together. The correlation coefficient measures the extent to which returns on Cotton are associated (or correlated) with Cocoa. Values of the correlation coefficient range from -1 to +1, where. The correlation of zero (0) is possible when the price movement of Cocoa has no effect on the direction of Cotton i.e., Cotton and Cocoa go up and down completely randomly.
Pair Corralation between Cotton and Cocoa
Assuming the 90 days horizon Cotton is expected to generate 7.66 times less return on investment than Cocoa. But when comparing it to its historical volatility, Cotton is 2.56 times less risky than Cocoa. It trades about 0.12 of its potential returns per unit of risk. Cocoa is currently generating about 0.36 of returns per unit of risk over similar time horizon. If you would invest 733,400 in Cocoa on September 1, 2024 and sell it today you would earn a total of 205,800 from holding Cocoa or generate 28.06% return on investment over 90 days.
| Time Period | 3 Months [change] |
| Direction | Moves Together |
| Strength | Insignificant |
| Accuracy | 95.65% |
| Values | Daily Returns |
Cotton vs. Cocoa
Performance |
| Timeline |
| Cotton |
| Cocoa |
Cotton and Cocoa Volatility Contrast
Predicted Return Density |
| Returns |
Pair Trading with Cotton and Cocoa
The main advantage of trading using opposite Cotton and Cocoa positions is that it hedges away some unsystematic risk. Because of two separate transactions, even if Cotton position performs unexpectedly, Cocoa can make up some of the losses. Pair trading also minimizes risk from directional movements in the market. For example, if an entire industry or sector drops because of unexpected headlines, the short position in Cocoa will offset losses from the drop in Cocoa's long position.The idea behind Cotton and Cocoa pairs trading is to make the combined position market-neutral, meaning the overall market's direction will not affect its win or loss (or potential downside or upside). This can be achieved by designing a pairs trade with two highly correlated stocks or equities that operate in a similar space or sector, making it possible to obtain profits through simple and relatively low-risk investment.| Cocoa vs. Oat Futures | Cocoa vs. Wheat Futures | Cocoa vs. Feeder Cattle Futures | Cocoa vs. Micro Silver Futures |
Check out your portfolio center.Note that this page's information should be used as a complementary analysis to find the right mix of equity instruments to add to your existing portfolios or create a brand new portfolio. You can also try the Global Correlations module to find global opportunities by holding instruments from different markets.
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