The Outlook For The FTSE 100

by at Plus500.
Alistair Meadows
Alistair Meadows

Long ago, the FTSE 100 ceased to be a domestically focussed Index; although domiciled in the UK, the vast majority of Index constituent sales (over 70%) are generated overseas, which explains why the Index tends to move inversely with the Sterling exchange rate.

Early Warning?

One of the less well-known realities is that the Index is often a canary in the coal mine, with regard to global stocks.

The UK Index peaked in December 1999, whilst the S&P 500 topped out in March 2000.

At the beginnings of the Mortgage Crisis of 2007, the FTSE 100 hit its high in June 2007, 3 months before the S&P Index.

The most recent peak (7903) for FTSE was registered in May 2018, whilst the S&P 500 Index is still making regular new all-time highs at present.

The FTSE 100 appears to anticipate changes in global equity market trends.

Recent Price Action

On the April 19th, the Index peaked at 7041, losing nearly 3% in just 2 days thereafter in what could be the start of a downtrend.

Since then the market has meandered slowly higher, taking 8 days to get to just above 7000, in a corrective-looking rally, as futures open interest has steadily fallen throughout this rise (indicating that the buying is coming from short covering).

However, sometimes the futures contract makes a new high (a sort of “fake out”) before the downtrend resumes in earnest.

If so, the Index should not go much above 7010 on the June contract (above which one should place a stop loss).

A move below 6980 on the future should confirm that the downtrend has begun.

Even if this is merely a correction, it should progress down to at least 6680.

One could just look to sell the FTSE Future (for June expiry), but there is a relatively low risk (and cheap) way to play this short-term outlook…

Low Risk Option

At current implied volatilities, Index options could be the best way to play this decline, as they have become much cheaper to buy as the post-pandemic recovery has progressed.

For example, a 6725 put, expiring on June 18th (with the futures just below 7000) would cost c.63p (so the cost of one option contract would be £630), giving an implied volatility of 16.8%, below the 6-month volatility for the Index, which currently stands at 18.5%.

Obviously, there are a number of assumptions required to accurately forecast an options’ value, but, assuming a fall to 6680 (on the cash Index) occurs within a fortnight and further assuming (very conservatively) no rise in option volatilities, the options’ value would be around 159, giving a healthy return of more than double the initial investment.

Of course, if the FTSE fails to decline below 6725, the options will expire worthless, meaning that the investor would lose all of the investment capital, so a sustained move above 7000 on the future would trigger the stop loss.

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