Pursuing ‘Risk-on, Risk-off’ Trades
November 17, 2011
The past year has witnessed much economic
turmoil. This turmoil is highlighted by several
significant market shaking events, including the
Japanese earthquake and tsunami, the U.S. debt
ceiling crisis, the ongoing European sovereign debt
crisis as well as the aftermath and recovery from the
subprime mortgage crisis.
As such, there is much interest in taking risk
exposures based on the prospects, or lack of,
economic flare-ups. Sometimes, these types of
positions are whimsically referred to as “risk-on,
risk-off” transactions with a nod to the Karate Kid
film franchise.
I.e., when economic tensions decline, you might
accept more risk – or turn your “risk-on” – by taking
an aggressive market position. When economic
tensions are expected to flare-up, reduce risk – or
turn your “risk-off” – by taking a defensive market
posture.
Economic tensions Turn “Risk-On” with
dissippating aggressive posture
Economic tensions Turn “Risk-Off” with
rising defensive posture
Risk-on, risk-off strategies may be as
straightforward as taking outright positions in
markets such as the S&P 500; gold; currencies; or,
U.S. Treasuries. During periods of visible economic
distress, these markets often become very
responsive to the same concerns and exhibit high
correlation. All of these outright positions may, of
course, be pursued using CME Group products. But
this inquiry focuses on some more elaborate risk-on,
risk-off measures including the following.
1. Australian dollar/Japanese yen (AUD/JPY) cross-
rate or cross-currency transactions;
2. Euro vs. U.S. dollar (EUR/USD), or Euro vs. Swiss
franc (EUR/CHF) currency pairings;
3. The Gold vs. S&P 500 spread; and
4. “Swap spreads” or credit spreads between
interest rate swap (IRS) and Treasury rates.
All of these transactions may likewise be traded
using CME Group products.
Australian Dollar/Japanese Yen – The spread
between the Australian dollar and Japanese yen has
gained favor as a leading measure of the macro-
economic “fear factor.”
Note that the Australian dollar (AUD) tends to
benefit when the price of raw commodities advance.
Australia is a commodity-rich nation and commodity
Page 1 of 4
prices including energy products, foodstuffs, metals,
minerals, etc., have advanced tremendously within
the past decade on demand from emerging market
nations, most notably including China. Thus,
prospects for economic growth, particularly in
emerging economies, tend to support the AUD.
On the other hand, Japan has emerged, in the post-
subprime mortgage crisis era, as a reasonably stolid,
albeit perhaps an unexciting economy. In particular,
the Japanese yen (JPY) advanced sharply in the post
financial crisis era (since 2008) as so-called “carry”
trades have been unwound on a large scale. 1 Thus,
the JPY is regarded as a relatively safe haven in
Asia.
AUD/JPY Exchange Rate
90
88
86
84
82
80
78
76
74
72
Mar-11
Jun-11
Apr-11
May-11
Aug-11
Sep-11
Dec-10
Jan-11
Feb-11
Oct-11
Jul-11
The spread between the AUD and JPY is widely
followed as a popular risk-on, risk-off mechanism.
In particular, the AUD/JPY “cross-rate” currency
pairing is offered as a CME Group futures contract.
The contract is based upon 200,000 AUD and is
quoted in Japanese yen per Australian dollars.
Thus, if economic tensions are dissipating and you
wish to adopt an aggressive risk-on position then
buy AUD/JPY futures. Or, if economic tensions are
1
A “carry” trade involves the purchase of a currency
offering high interest rates, coupled with the sale of a
currency offering low interest rates. The concept is
essentially to borrow at low rates and leverage those
funds by investing at relatively higher rates. Prior to the
subprime mortgage crisis, which was at its height in
2008, the Japanese yen was the favored short in carry
trades placed by asset managers and hedge funds.
Subsequent to the crisis, however, asset managers and
hedge funds generally unwound those carry trades,
covering their JPY short positions and sending the JPY
much higher. At the same time, rates in other
developed nations, notably including the U.S., fell to
levels comparable to those in Japan. Thus, the JPY fell
out of favor as the preferred short in carry trades.
 Pursuing ‘Risk-on, Risk-off’ Trades
November 17, 2011 Page 2 of 4

rising and you wish to adopt a more defensive risk-
off position, then sell AUD/JPY futures.
“Risk-On”
“Risk-Off”
Note that if you buy AUD/JPY futures, you are
effectively taking a long position in the Australian
dollar and a short position in the Japanese yen. If
you sell AUD/JPY futures, you are effectively taking
a short position in the Australian dollar and a long
position in the yen.
EUR/USD & EUR/CHF – To the extent that much
of the economic stress over the past year has been
occasioned by the European sovereign debt crisis, it
is natural to ask what effect this has exerted upon
the Eurozone currency in the form of the Euro
(EUR). When “Eurostress” builds, that weighs on
the Euro and traders seek refuge in other currencies
not so impacted including the U.S. dollar (USD) and
the Swiss franc (CHF). When Eurostress eases, then
the Euro may rebound relative to the USD, CHF and
other currencies.
This is evident by examining a comparative chart of
the EUR/USD and EUR/CHF currency pairings. Both
of these currency pairs declined in the summer to
early fall as the European sovereign debt crisis
reached a fever pitch. But they declined at very
uneven rates. In particular, the EUR/USD rate held
reasonably firm until early August. This firmness
might be attributed to weakness in the U.S. dollar to
the extent that the debt ceiling crisis weighed on the
USD.
dollars per Euros. Similarly, CME Group offers a
EUR/CHF contract based upon a unit of 125,000
Euros. This contract is quoted in Swiss francs per
Buy AUD/JPY futures Euros.
Sell AUD/JPY futures
Buy EUR/USD futures or
“Risk-On”
Buy EUR/CHF futures
“Risk-Off”
Sell EUR/USD futures or
Sell EUR/CHF futures
Thus, one might take a more aggressive risk-on
posture when economic tensions are reduced by
buying the EUR/USD or the EUR/CHF futures
contracts. Or, adopt a more defensive risk-off
posture by selling the EUR/USD or EUR/CHF futures
contracts. Note that the purchase of these contracts
implies a long position in the Euro and a short
position in either the USD or CHF. The sale of these
futures contracts implies a short position in the Euro
and a long position in either the USD or CHF.
Gold/S&P 500 – Yet another interesting risk-on,
risk-off trade may be identified as the spread of gold
vs. the S&P 500. Our graphic depicts the gold/S&P
spread as the ratio of the price of gold, quoted in
U.S. dollars per one fine troy ounce, over the index
value of the S&P 500. The quote is further
normalized to an arbitrary value of 1,000.00 as of
December 31, 2010. As such, this quote effective
represents a long gold position vs. a short S&P 500
position.
VIX vs. Gold/S&P Index
50% 1,600
45% 1,500
S&P 500 VIX Index

Gold/S&P 500 Index

40% 1,400
EUR/USD and EUR/CHF
1.50 1.35 35% 1,300

1.30 30% 1,200

1.45
25% 1,100
1.25
20% 1,000
EUR/USD

EUR/CHF

1.40 1.20
15% 900
1.35 1.15
10% 800
1.10
Mar-11

Jun-11
Apr-11

May-11

Aug-11
Sep-11
Dec-10

Jan-11
Feb-11

Jul-11

1.30
1.05

1.25 1.00 VIX Gold/S&P Fear Index

Mar-11

Jun-11
Apr-11
May-11

Aug-11
Sep-11
Dec-10
Jan-11
Feb-11

Oct-11
Jul-11

We compare the gold/S&P spread to the value of the

S&P 500 VIX or S&P 500 Volatility Index. 2 Note
EUR/USD EUR/CHF

2
Note that CME Group offers a EUR/USD contract The VIX represents an amalgam of implied volatilities
(IVs) gleaned from Chicago Board Option Exchange
which calls for the delivery of 125,000 Euros vs. an
(CBOE) options based on the Standard & Poor’s 500.
equivalent value in USD. This contract is quoted in The VIX is widely regarded as a convenient measure of
 Pursuing ‘Risk-on, Risk-off’ Trades
November 17, 2011 Page 3 of 4

that both the gold/S&P and VIX indexes tend to mini S&P 500 futures are cash settled based upon a
move closely in tandem. Both measures spiked in value of $50 x Index.
response to economic flare-ups including the
Japanese earthquake and tsunami early in 2011, as “Risk-On” Sell Gold/S&P 500 spread
well as heightened concerns about European “Risk-Off” Buy Gold/S&P 500 spread
instability by mid-year.
If economic tensions are declining and you wanted
This gives us further occasion to note the high to adopt an aggressive risk-on posture, sell the
correlation between the S&P 500 and the VIX. gold/S&P spread, i.e., sell gold and buy S&P 500
Actually, the two instruments are negatively or futures. If economic tensions are rising and you
inversely correlated (i.e., equity market volatility wanted to adopt a defensive risk-off posture, buy
tends to increase when stocks decline; and, tends to the gold/S&P spread, i.e., buy gold and sell S&P 500
fall when stocks advance). futures. Because these two contracts are very
different, one might place the spread in a ratio
Inverse S&P 500 vs. VIX represented by relative monetary values of the two
-1,050 50% futures.
-1,100 45%
Swap Spreads – Finally, let us consider so-called
Inverse of S&P 500

40%
-1,150 “swap spreads” or the spread between the fixed
35%
VIX Index

-1,200 interest rate associated with over-the-counter (OTC)

30% interest rate swaps (IRS) vs. U.S. Treasury
-1,250 securities of similar maturity. This spread may be
25%
considered a form of “credit spread” to the extent
-1,300
20% that it compares private vs. public credit risks.
-1,350 15%
Our graphic depicts the swap spread using data from
-1,400 10%
the U.S. Treasury Department’s daily H15 report.
Mar-11
Apr-11
May-11

Aug-11
Jan-11
Feb-11

Jun-11

Sep-11
Dec-10

Jul-11

Thus, we are comparing 2-, 5-, 10- and 30-year

LIBOR-based interest rate swap instruments to
“Constant Maturity Treasury” (CMT) yields. These
Inverse S&P 500 VIX spreads tend to advance and decline as a function of
credit conditions and the macroeconomic “fear
This inverse relationship is intuitive to the extent factor.”
that stocks tend to rally slowly and steadily.
Consider that millions of domestic employees Swap Spreads
participate in 401K retirement funds. Thus, every 0.80%
payday, a proportion of their earnings are directed
0.60%
to investment accounts, largely stock mutual funds.
As such, investment is slowly and steadily directed 0.40%
into equities. 0.20%

But when an event occurs that causes investors to 0.00%

pull back from equity investments, the withdrawals -0.20%
tend to be swift, sudden and of large magnitude.
I.e., stocks tend to rally slowly and steadily but -0.40%
decline swiftly and suddenly, with the obvious -0.60%
inverse impact upon volatility as measured by the
-0.80%
VIX.
Mar-11

Jun-11
Apr-11

May-11

Aug-11

Sep-11
Dec-10

Jan-11

Feb-11

Jul-11

Note that the gold/S&P 500 spread may be pursued

with the use of CME Group contracts. The gold
futures contract calls for the delivery of 100 fine troy 2-Yr Swap Spread 5-Yr Swap Spread
10-Yr Swap Spread 30-Yr Swap Spread
ounces of gold and is quoted in USD per 1 oz. E-
Note that the spread has actually turned negative in
the 30-year sector of the yield curve. The
volatility in the domestic equity markets and, as such, explanation lies, not in risk-on, risk-off relative
represents a “fear factor index” in its own right.
 Pursuing ‘Risk-on, Risk-off’ Trades
November 17, 2011 Page 4 of 4

factors, but more so in simple supply and demand
considerations.
In particular, so-called liability-driven investment
(LDI) managers have increasingly turned to long-
term IRS as an alternative to 30-year Treasury
investment. This is driven, in large part, by limited
supply relative to demand in the very long-term
segment of the yield curve. This demand is
redirected into IRS and has resulted in a negative
30-year swap spread.
Note that CME Group offers 5-, 7-, 10- and 30-year
interest rate swap futures contracts. We further
offer standard Treasury covering the 2-, 3-, 5-, 10-
and 30-year sectors of the curve; as well as on-the-
run (OTR) Treasury futures covering the 2-, 5- and
10-year portions of the curve. Thus, one may
construct a weighted spread to take advantage of
risk-on, risk-off conditions.
If you believed that economic tensions are
dissipating and wanted to adopt a risk-on position,
then buy Swap/Treasury spreads. If you believed
that economic tensions might flare up, then adopt a
risk-off position by selling Swap/Treasury spreads.
Swap/Treasury spread, you are selling swap futures
and buying Treasury futures in anticipation that the
yield spread might expand.
Concluding Note – The concept of “risk-on, risk-
off” trading has won increasing interest and
popularity in recent years. There are, of course,
many ways to construct transactions that are
sensitive to these macroeconomic conditions.
CME Group offers various products and spread
products in the context of our currency, stock index,
commodity and interest rate product lines that may
be used to take position oneself with an appropriate
risk exposure to advantage oneself from anticipated
conditions.
For more information, please contact …
Sandra Ro, Director
Research & Product Development
011 (44) 203-379-3789, sandra.ro@cmegroup.com
Richard Co, Director
Equity Products
312-930-2310, Richard.co@cmegroup.com

Buy Swap/Treasury Mike Kamradt, Director

“Risk-On”
futures spreads Interest Rate Products
Sell Swap/Treasury 312-466-7473, mike.kamradt@cmegroup.com
“Risk-Off”
futures spreads
John W. Labuszewski, Managing Director
Note that by buying a Swap/Treasury spread, you Research & Product Development
are buying swap futures and selling Treasury futures 312-466-7469, jlab@cmegroup.com
in anticipation that the yield spread between the two
instruments might compress. By selling a

Copyright 2011 CME Group All Rights Reserved. Futures trading is not suitable for all investors, and involves the risk of loss. Futures
are a leveraged investment, and because only a percentage of a contract’s value is required to trade, it is possible to lose more than the
amount of money deposited for a futures position. Therefore, traders should only use funds that they can afford to lose without affecting
their lifestyles. And only a portion of those funds should be devoted to any one trade because they cannot expect to profit on every trade.

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The information within this presentation has been compiled by CME Group for general purposes only. CME Group assumes no responsibility
for any errors or omissions. Although every attempt has been made to ensure the accuracy of the information within this presentation, CME
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