Write a daily contrarian rule from the closed-end-fund discount

Treat the discount as a construction problem

Sentiment gauges are split into direct and indirect families. This construction uses a closed-end-fund discount series as the indirect sentiment indicator, rather than a survey of stated investor views.

The closed-end-fund discount is treated as a contrarian indicator, in contrast to a coinciding options-sentiment style gauge. The workflow writes one daily rule that turns yesterday’s premium or discount into today’s stance.

Form yesterday’s gap

The daily discount percentage is the natural log of the prior mid-price divided by the prior net asset value. Mid-price is the average of a session’s open and close, and both the mid-price and the net asset value are taken from the prior day when the discount is computed.

Map the gap to today’s stance

The daily rule takes a long stance in the euro currency ETF when the prior mid-price sits below net asset value and a short stance when it sits above. In this contrarian strategy, a premium maps to a sell stance and a discount maps to a buy stance, fading the implied sentiment of that gap.

Which way the write-up looks

A scatter of daily euro-ETF returns against the lagged discount is described as slightly negatively sloped. A one-variable regression on 2518 observations reports a negative daily-return coefficient.

Daily returns are used to predict the discount series because the write-up states that evidence for the reverse direction, sentiment forecasting prices, is not established.

Read rising prices as crowding in

Rising prices are framed as a crowding-in effect that is later discounted, not as a reason for sentiment to become more bullish.

Editorial reading

Editorial: the object to keep is the full daily procedure. Once the prior premium or discount is written as today’s long or short stance, entry, exit and fade can be tested together instead of as separate calls on the next print.