Chart 27: Both HSCEI and NKY term structures are near record steeps; we favor calendar puts to hedge downside risks
15%
10%
5%
0%
-5%
2 2 OO TT NN OO TT OO Oo Oo SSSSESSESSESESE8S8 35 ———NKY 3M-12M ATM Vol = ===HSCEI 3M-12M ATM Vol Source: BofA Merrill Lynch Global Research Data as of 2-Jan-09 to 16-Jun-17 Chart 28: The Nikkei/Topix ratio and its volatility is capped with the Bo)’s ongoing yield curve control ; O06 3 2.9 04 3 5 27 02 § g 12.5 0 > a& 12.3 02 3 > 04 2 a 12.1 9 = 18 06 & c os © 17 { o 11.5 1.2
NNN OO MO DS Tt OO ODO Oo Oo LE c<ct SBE aQoaesz oH ER WE SE SSSERSR2RFSEPES
——=NKY/TPX Ratio === 10Y JGB Yield
Source: BofA Merrill Lynch Global Research
Data from 2-Jan-12 to 16-Jun-17
AS51 3M ATM IV over HSCEI is at its 4-year high Table 4 lists Asian index pairs with the highest IV ratio vs their 4-year histories. For
instance, the ratio of AS51 3M ATM IV over HSCEI is at its 4-year high.
Calendar puts are attractively priced given the steep term structure
With the continuous low realized volatility environment, both NKY and HSCEI 3-month minus 12-month term structures steepened to -3.7 vol points, which are near multi-year lows.
As our Strategists think the Fed now appears concerned about surging asset prices, investors should consider downside hedges. Calendar puts, i.e. buying short-dated ATM puts and selling long-dated OTM puts, are attractively priced given the steep term structure.
Currently, we still have an open trade on NKY calendar puts (buy Jul-17 19,500 puts vs sell Dec-17 17,500 puts) to hedge downside risks.
The Bo)’s ongoing yield curve control has capped the Nikkel/Topix ratio and its volatility
Japanese government bond (JGB) yield has been on a downward trend over the last few years and has negatively impacted bank earnings. As the Topix has higher weightings in banks than the
Nikkei, the NKY/TPX ratio has been grinding higher.
However, the NKY/TPX ratio appears to have flattened out since the Bo}’s commitment to maintain the 10-year JGB yield at around 0% in September 2016. With global central banks increasingly advocating tighter monetary policies, the market may start to speculate Bo)’s exit strategy and this may reverse NKY/TPX’s upward trend. With TPX vol trading below NKY vol, buying TPX calls funded by NKY calls may perform well in such a scenario.
Bankof America Merrill Lynch
Global Equity Volatility Insights | 20 June 2017 19
HOUSE_OVERSIGHT_014990