Topics for June
Copyright (c) 1998 Commodity Systems Inc. (CSI). All rights are reserved.
Topics discussed in this month's journal.
The year 2000 will mark the 30th anniversary of CSI's most enduring and successful product, Perpetual Contract data. Even today, nearly three decades after its development for professional market analysis, it is still a controversial tool in the trader's arsenal. We have recently increased the flexibility of Perpetual Contract data formulation through the Unfair Advantage® platform, which seems to have further fueled the debate about the pros and cons of blending away the gap between old and new contracts. Here's why I love Perpetual Contract data - the tool that some traders love to hate.
What's in a name?
The term "Perpetual Contract" is a registered service mark of CSI, so it is protected from use by other firms by international law. The term derives its distinctiveness, in part, from its oxymoronic use of the word "perpetual," meaning unending, in conjunction with "contract," referring to the time-sensitive and finite arrangement between buyers and sellers. No other firm has the legal right to market a futures-related product called a "Perpetual Contract," or "perpetual data", or "perpetual futures contract," or use the term "perpetual" with respect to data products in the futures industry, etc. because of CSI's development of the mark and the concept behind it.
What is it?
Perpetual Contract data represents a time-weighted average of the prices of the two active contracts whose expiration dates lie earlier and later than a fixed number of days ahead of the current date. This computed contract provides an accurate view of the market's characteristic price-pattern waveform over time.
To clarify the issues and add some perspective, we decided to present some material on the subject of this very powerful tool. Perpetual Contract data was developed as a way to process American-style futures markets. The forward markets of the London Metal Exchange produce time series that are perpetual in nature because they always expire just 90 days forward or six months forward, etc. The trader at the LME who buys a 90-day forward copper contract will expect delivery in exactly 90 days following the purchase date. The LME trader who engages in such a transaction will not readily know from reviewing the newspaper how valuable his particular contract has become. This is because, on each and every subsequent trading day, a new contract is born that will likewise expire 90 days hence.
The trader who took a position last week may assume that his particular contract is going up or down based upon reports on the activity of subsequent contracts being traded, but he will not always be correct. The situation of the contract purchased may just as likely be known from producer and consumer pricing in the cash market as the current forward contract being traded. The focus will change to the cash market as the contract held moves closer to delivery.
In U.S, markets, the birth and death cycle of futures products raises real concerns for the trader who would like to investigate modeling considerations and scenarios through the examination of long periods of historical information. Many analysts have been led to the Perpetual Contract as a proxy for synthesizing long-term market patterns.
What's not to like?
We love Perpetual Contract data, and it is obvious that many investors do, too. We have noticed the heated exchanges on various chat forums among traders who use Perpetual Contract data for their analysis and back testing of modeling scenarios of futures data. In spite of the fact that we have never represented Perpetual Contract data as a tradable commodity, some seem unwilling to accept it as a non-tradable analysis tool. In one of Jack Schwager's books he correctly represents that it is not possible to trade Perpetual Contract data in the real market. He and other vocal opponents of Perpetual Contract data seem to have a problem with this concept.
What's to like?
What Perpetual Contract data does for the analyst is provide a barometer of market activity that will monitor the market from a statistically stationary point of view and from a constant time-forward perspective. You cannot trade Perpetual Contract data, but by using it to derive your market wisdom and trade direction, stability will be the norm, and you will experience less in terms of false market turns that get you in or out of the market early or late. The user can adjust nearby market focus with Perpetual Contract data by varying the forward period of view.
The analytical and statistical stationarity and stability of a Perpetual Contract data series should not be viewed as a detriment to trading success. Statistical stationarity is a positive attribute that any time series analyst should attempt to achieve. Stationarity is present when the distribution parameters of mean and variance remain fixed. To use statistics to predict the futures market, one should at least consider processing data that has a constant time-period forward focus.
Traditional commodity futures, which repeatedly experience the birth-death process of contract inception to contract delivery, do not focus on a constant time to expiration. Trading begins and lasts until a contract ends, at some point, the trader considers moving to the next contract and repeats the process over and over again. Perpetual Contract data, on the other hand, never expires, so every simulated trade that is initiated experiences the very same time-period forward focus.
Uncovering special opportunities
Here at CSI, we see each market as an opportunity to trade any one commodity against another through a spread trade or as a time series that would fit into some form of a multi-market arrangement. In either case, it is very convenient to track all groups or pairs of markets with a common time-forward perspective that only Perpetual Contract data can offer. The time-forward averaging will remove distortions that could foster trading errors and false invitations to switch trade direction.
Another consideration that makes Perpetual Contract data valuable is the possibility of pairing off raw materials with finished products. For example, far-forward future hogs might be traded off with a nearby future corn. (Corn is the raw material needed to produce the hogs after a nine-to-12 month lag in turning the raw corn into the finished hog.) Perpetual Contract data allows users to study the dependent impact of these two commodities upon each other.
Using Perpetual Contract Data in the real world:
So now that we may have talked you into trying this tool to track your favorite market, you are quite possibly still wondering how to apply the information. A common question involves the selection of the real contract that should be traded based on your Perpetual Contract data analysis. The answer will depend upon how your system works, and your estimated average trade duration.
Most traders like to avoid the very volatile nearest future, and some may like the relative tameness of the more distant contracts. Clarifying which situation suits your needs should help to govern your choice of both the time-forward period of the Perpetual Contract data series and the contract to which you will apply your derived trading signals. In other words, if you would normally trade contracts that are three months from delivery, then the three-month Perpetual Contract data should also be your choice, provided your trade duration can fit into the chosen forward period.
In general, when using Perpetual Contract data to follow agricultural products, one should favor new crop positions over old or avoid such markets altogether. Please read the UA manual's essay on computed contracts for more information.
CSI's soon-to-be released Multi-Market Analyzer uses our Perpetual Contract data to examine large groups of markets at once, with similar lagged or non-lagged effects. That tool will also allow the use of seasonal index data so that relationships between contra-seasonal forces in one commodity versus another can be explored. Only through a vast repository of data such as is offered by Unfair Advantage can such interrelated markets be exploited for maximum benefit.
Love it or hate it? You decide:
Now that our Perpetual Contract
data is approaching the very mature age of 30, we hope that you'll join the
growing number of traders who have an opinion one way or the other. If you are
curious about Perpetual Contract data, why not give it a try on paper?
Perpetual Contract data is available through QuickTrieve, where it can be
ordered by delivery month code, and can be formulated directly from the
compressed database through Unfair Advantage. Let us know what you think.
There's just one important thing to remember: You can't trade Perpetual
Contract data, but that's not a problem!