Correlation Between Cotton and Lumber Futures

Can any of the company-specific risk be diversified away by investing in both Cotton and Lumber Futures 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 Lumber Futures into the same portfolio, which is an essential part of the fundamental portfolio management process.

By analyzing existing cross correlation between Cotton and Lumber Futures, you can compare the effects of market volatilities on Cotton and Lumber Futures 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 Lumber Futures. Check out your portfolio center. Please also check ongoing floating volatility patterns of Cotton and Lumber Futures.

Diversification Opportunities for Cotton and Lumber Futures

-0.43

Correlation Coefficient

Cotton  Lumber Futures

Very good diversification

The 3 months correlation between Cotton and Lumber is -0.43. Overlapping area represents the amount of risk that can be diversified away by holding Cotton and Lumber Futures in the same portfolio, assuming nothing else is changed. The correlation between historical prices or returns on Lumber Futures 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 Lumber Futures. Values of the correlation coefficient range from -1 to +1, where. The correlation of zero (0) is possible when the price movement of Lumber Futures has no effect on the direction of Cotton i.e., Cotton and Lumber Futures go up and down completely randomly.

Pair Corralation between Cotton and Lumber Futures

Assuming the 90 days horizon Cotton is expected to under-perform the Lumber Futures. But the commodity apears to be less risky and, when comparing its historical volatility, Cotton is 1.69 times less risky than Lumber Futures. The commodity trades about -0.03 of its potential returns per unit of risk. The Lumber Futures is currently generating about 0.19 of returns per unit of risk over similar time horizon. If you would invest  55,450  in Lumber Futures on December 29, 2024 and sell it today you would earn a total of  12,550  from holding Lumber Futures or generate 22.63% return on investment over 90 days.

Time Period	3 Months [change]
Direction	Moves Against
Strength	Very Weak
Accuracy	96.88%
Values	Daily Returns

Cotton  vs.  Lumber Futures

Cotton

Risk-Adjusted Performance

Very Weak

Over the last 90 days Cotton has generated negative risk-adjusted returns adding no value to investors with long positions. In spite of fairly strong basic indicators, Cotton is not utilizing all of its potentials. The current stock price disturbance, may contribute to short-term losses for the investors.

Lumber Futures

Risk-Adjusted Performance

Good

Compared to the overall equity markets, risk-adjusted returns on investments in Lumber Futures are ranked lower than 14 (%) of all global equities and portfolios over the last 90 days. In spite of rather weak basic indicators, Lumber Futures exhibited solid returns over the last few months and may actually be approaching a breakup point.

Pair Trading with Cotton and Lumber Futures

The main advantage of trading using opposite Cotton and Lumber Futures positions is that it hedges away some unsystematic risk. Because of two separate transactions, even if Cotton position performs unexpectedly, Lumber Futures 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 Lumber Futures will offset losses from the drop in Lumber Futures' long position.

The idea behind Cotton and Lumber Futures 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.

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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 Price Exposure Probability module to analyze equity upside and downside potential for a given time horizon across multiple markets.