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Global Equity Volatility Insights
Want a cheap call on EU equity? Monetise correlation through EU bank dispersion

Bank of America Merrill Lynch

20 June 2017

US
Extract alpha from summer SPX range as policy and positioning "collar" equities
With the Federal Reserve last week appearing more emboldened to normalize monetary policy, risk asset bears have come out in force. While we agree that a changing Fed reaction function is likely not supportive of substantial equity upside, we think the "Yellen put" still exists, albeit with a lower strike. Hence, we see monetary policy as providing a near-term "collar" (long put/short call) on a US equity market already prone to getting trapped in record-tight trading ranges. Further impetus for a summer range-trade should come from (i) fiscal policy, as gridlock caps equity upside but policy hope floors the downside, and (ii) positioning, where the risk of continued "fragility events" (potentially exacerbated by stretched quant fund/short vol positioning) meets cashed-up investors still accustomed to buying dips. As a risk-limited range trade, we like buying in-the-money down and out puts on the S&P. For example, an SPX Sep 2475 put that knocks out at 2300 (6% OTM) indicatively costs 70bps (spot ref 2451), a 60% discount to the 2475 / 2300 put spread.

Europe
Long EU banks dispersion: Buy Dec17 call on a basket, sell worst-of call
We recommend positioning for greater dispersion in EU bank sector returns via buying a Dec17 105% call on an equally-weighted basket of Santander, BNP, ING, Intesa and Deutsche Bank, part-financed by selling a worst-of call on the same basket for 1.8% (net) indic., as: 1) improving macro/earnings, sensitivity to rates and regulatory headwinds are likely to lead to greater differentiation within banks, 2) the entry point is attractive given historically low implied vol (13th 8y+ percentile) and high implied correlation (81% bid vs latest 6M realised correl of 66%), 3) historical risk-reward at current pricing is attractive (avg. P&L of +8.4% when positive vs -1.8% when negative), and 4) the trade can be considered as a cheap call on EU equities as it has a similar payoff profile but with greater benefit relative to its cost.

Asia
Buy depressed China vs. US risks through corridor variance spreads
As global central banks have taken on more hawkish tones, the uncertainty surrounding policy tightening will be more positive for EM volatility than for DM volatility.
Additionally, our strategists have a more bearish outlook for the Chinese banking sector (which makes up a majority of the HSCEI index) amid rapidly rising leverage, complex shadow banking, and excessive home price inflation. Since we believe the global synchronized monetary tightening will impact HSCEI volatility more than SPX volatility, we recommend owning HSCEI-SPX 70/110% corridor variance at 5 vol points, a 3 vol point discount to a vanilla variance spread. The entry point is attractive as the HSCEI-SPX 18-month variance swap spread has fallen back to the lower-end of its 5-year trading range, the trade has a positive carry, and it benefits during China risk-off events.

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Equity Derivatives
Global
BofA Analytics
-- DATA DRIVEN --

Global Equity Derivatives Rsch
MLPF&S

Anshul Gupta >>
Equity-Linked Analyst
MLI (UK)

Nitin Saksena
Equity-Linked Analyst
MLPF&S

William Chan, CFA >>
Equity-Linked Analyst
Merrill Lynch (Hong Kong)

Abhinandan Deb >>
Equity-Linked Analyst
MLI (UK)

Benjamin Bowler
Equity-Linked Analyst
MLPF&S
benjamin.bowler@baml.com

Jason Galazidis >>
Equity-Linked Analyst
MLI (UK)

Clovis Couasnon >>
Equity-Linked Analyst
MLI (UK)

Chintan Kotecha
Equity-Linked Analyst
MLPF&S

Michael Youngworth
Equity-Linked Analyst
MLPF&S

Nikolay Angeloff
Equity-Linked Analyst
MLPF&S

See Team Page for List of Analysts

Table 1: 3M volatility (weekly changes)
Implied Realized
S&P500 9.8 (-0.2) 7.1 (-0.2)
ESTX50 13.4 (0.3) 11.5 (0.2)
FTSE 10.0 (-0.4) 9.7 (0.2)
DAX 12.6 (0.3) 10.7 (0.5)
NKY 13.8 (-0.2) 12.3 (-0.2)
HSI 12.4 (0.1) 10.1 (0.2)
KOSPI 12.2 (0.3) 10.5 (0.1)
EEM US 15.6 (0.5) 11.8 (-1.1)
TOP40 16.9 (1.2) 11.1 (0.3)
RDX 25.9 (0.9) 20.6 (-1.1)
IBOV 22.9 (-1.7) 25.5 (-0.7)
ISE30 20.2 (0.4) 13.5 (0.1)
Source: BofA Merrill Lynch Global Research

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11756528
Timestamp: 20 June 2017 01:18AM EDT
HOUSE_OVERSIGHT_014972