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Financial research report
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2.07 MB
Summary
This document is page 7 of a 'Global Equity Volatility Insights' report published by Bank of America Merrill Lynch on June 6, 2017. The text provides technical financial analysis regarding hedging strategies for 'Tech positions' and 'asset bubbles,' specifically recommending '3M put spreads on NDX' and '12M SPX Top50 dispersion' strategies. It contains two charts analyzing implied volatility and correlation spreads. The document bears the Bates stamp 'HOUSE_OVERSIGHT_023581', suggesting it was included in document production for a House Oversight Committee investigation, likely related to financial institutions' records.
Organizations (2)
| Name | Type | Context |
|---|---|---|
| Bank of America Merrill Lynch |
Financial institution publishing the 'Global Equity Volatility Insights' report.
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| House Oversight Committee |
Implied by the Bates stamp 'HOUSE_OVERSIGHT', indicating this document was produced for a congressional investigation.
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Timeline (1 events)
Key Quotes (3)
"Hedge inflation & deflation of a Tech Bubble via SPX 12M Top50 dispersion"Source
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Quote #1
"we recommend investors go long 12M SPX Top50 dispersion."Source
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"long vol dispersion strategies can profit from both the inflation and deflation of an asset bubble, without requiring an investor to time the top."Source
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Quote #3
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Complete text extracted from the document (3,285 characters)
For those who wish to remain fully invested and/or seek broader index-level hedges for Tech positions, we suggest 3M put spreads on NDX for two reasons: (i) our cross-asset hedging analysis (Chart 15) shows little value in proxy hedging Nasdaq 100 exposure, even with relatively lower vol S&P options, as the basis risk has tended to be too high historically for proxy hedging to be reliably beneficial; and (ii) compared to outright puts, put spreads help limit long exposure to short-dated NDX implied volatility that is low but not cheap (Chart 14).
Hedge inflation & deflation of a Tech Bubble via SPX 12M Top50 dispersion
Dispersion strategies can be particularly attractive hedges for asset bubbles as idiosyncratic market moves generate high volatility (to which dispersion is positively correlated) with a limited rise in correlation (to which dispersion is negatively correlated). Importantly, as seen from Chart 11, this can occur both during the run-up to the market peak as well as after the bubble pops. In other words, long vol dispersion strategies can profit from both the inflation and deflation of an asset bubble, without requiring an investor to time the top.
Dispersion strategies can be particularly attractive hedges for asset bubbles as idiosyncratic market moves generate high volatility (to which dispersion is positively correlated) with a limited rise in correlation (to which dispersion is negatively correlated). Importantly, as seen from Chart 11, this can occur both during the run-up to the market peak as well as after the bubble pops. In other words, long vol dispersion strategies can profit from both the inflation and deflation of an asset bubble, without requiring an investor to time the top.
With the SPX Top50 largely dominated by Tech stocks (34% of total market cap) and with average longer-dated single stock vol in the basket trading close to 3yr lows (12M SPX Top50 ATMf implied vol is in its 2nd %-ile since Jun-14, Chart 16), we recommend investors go long 12M SPX Top50 dispersion. Chart 18 shows that such a strategy would have recorded its best performance during the formation and subsequent bursting of the dotcom bubble as volatility increased in tandem with falling correlation (see Chart 11).
Importantly, while implied correlation continues trading in a new, lower range since the US election, the spread to realized correlation has remained healthy with the SPX Top50 12M implied vs. 6M realized correlation spread in its 81st %-ile over the past 3 years (Chart 17). This makes selling the correlation premium (inherently embedded in long dispersion strategies) attractive vs. history.
Chart 16: Average SPX Top50 single stock 12M ATMf implied vol is depressed vs. history, in part driven by Tech market cap dominating the index and Tech vol the 2nd lowest across sectors on a historical basis
[Chart Graphic showing Bar Graph with categories: SPX Top50, Tech, Health Care, Discretionary, Staples, Financials, Industrials, Energy, Telecom]
Legend: 3yr %-ile of average 12m ATMf implied vol
Legend: Sector market cap as a %-age of total SPX Top50 market cap
Source: BofA Merrill Lynch Global Research. Daily data from 5-Jun-14 to 5-Jun-17.
[Chart Graphic showing Bar Graph with categories: SPX Top50, Tech, Health Care, Discretionary, Staples, Financials, Industrials, Energy, Telecom]
Legend: 3yr %-ile of average 12m ATMf implied vol
Legend: Sector market cap as a %-age of total SPX Top50 market cap
Source: BofA Merrill Lynch Global Research. Daily data from 5-Jun-14 to 5-Jun-17.
Chart 17: Implied to realized correlation spread on the SPX Top50 basket is historically elevated, making selling the correlation premium embedded in long dispersion strategies attractive
[Chart Graphic showing Line Graph with dates Jun-14 to Jun-17]
Legend: SPX Top50: 12m ATMf implied vs. 6m realized correlation (A - B)
Legend: 12m SPX Top50 ATMf implied correlation (A)
Legend: 6m SPX Top50 realized correlation (B)
Legend: Current (81st %-ile)
Source: BofA Merrill Lynch Global Research. Daily data from 2-Jun-14 to 2-Jun-17.
[Chart Graphic showing Line Graph with dates Jun-14 to Jun-17]
Legend: SPX Top50: 12m ATMf implied vs. 6m realized correlation (A - B)
Legend: 12m SPX Top50 ATMf implied correlation (A)
Legend: 6m SPX Top50 realized correlation (B)
Legend: Current (81st %-ile)
Source: BofA Merrill Lynch Global Research. Daily data from 2-Jun-14 to 2-Jun-17.
Bank of America Merrill Lynch
Global Equity Volatility Insights | 06 June 2017
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HOUSE_OVERSIGHT_023581
Global Equity Volatility Insights | 06 June 2017
7
HOUSE_OVERSIGHT_023581
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