Over the last 20 years equity markets and ETFs did a significant part of their total performance over night. This article will examine the relationship of in-session moves vs. the out-of-session moves of ETFs and commodities.
The overnight risk premium
As an investor you can expect to get paid for taking risk. If someone sell its stock to you he gets the risk free return for holding cash, but you will have to finance the risk of the stock moving against you. This risk is quite low when the market is open and liquid, as you could always sell the stock in case of an adverse movement. But when markets are closed you have to bear a higher risk as you will be bound to your position until the markets opens on the following day.
According to this theory the market returns over night should be positive, to compensate you for the higher risk of holding a position you can’t liquidate immediately. Let’s see if there is some truth in this theory and how big the overnight risk premium might be.
Test code and data
ETFs overnight risk premium
The chart below shows the outcome of the calculation for the QQQ ETF. As it can be seen, the good performance over the last years has happened mostly when markets where closed. Even during the financial crisis the overnight returns have mostly been positive.
Having a look at the distribution of returns you see quite a different behaviour on e.g. a rolling sum of 10 day or night moves. The daily open to close returns show a higher tendency for big moves than the overnight move. So from a risk perspective the day session bears more risk than the night session.
QQQ is not the only ETF showing this excess overnight performance. The overview below gives you the data. The numbers show the sum of percent moves since 2001. (starting at 100)
A look at commodities
With futures and commodities this overnight effect is not as prolonged as with equities. Sometimes it even is non existent at all.
The chart below shows the overnight and daytime performance of the German Bund future. Beside the phase from 2015 to 2017 the overnight movement did not add to the total performance.
The december future on emission certificates (chart below) shows no significant overnight movement at all.
German power, yearly contract, shows a strong negative overnight performance.
Implications for trading
As the overnight move has got a significant impact on the total performance of equity markets, it will also have implications on the design of a trading strategy. A first implication of this overnight effect might be that you should not be short over night in equity markets, and you might not want to open your long position at the beginning of the day. But keep in mind, if everyone knows the trick, this overnight movement will have implications for the first and last hour of trading. This will be a topic for another article…