Global Equity Volatility Insights BankofAmerica Understanding when risk parity risk Merrill Lynch
increases
09 August 2016 Corrected
US Equity Derivatives Global
Quantifying the (bond-equity correlation) risks to risk parity
Last week’s sharp sell-off in JGBs renewed concerns of forced selling by risk parity funds. While the drawdowns in US Treasuries, US equities, and ultimately risk parity portfolios were small and short-lived, the latent risk remains worth monitoring, as (i}
leverage is still near max levels across a variety of risk parity parametrizations, (ii) bond Global Equity Derivatives Rsch allocations are historically elevated, and (iii) markets continue to be sceptical of a 2016 MMAR Fed hike. Hence we provide a simple scenario tool to help investors assess what relative Set iey here moves in bonds and equities could catalyse significant deleveraging by rules-based risk MLPF&S parity funds running vol target overlays. For example, a -2% daily decline in the S&P Ur ah Say 500 coupled with a -0.6% fall in 10y Treasury prices (poor diversification) could trigger a Laine 25% deleveraging (of unlevered notional) today, whereas a -4% SPX drop and +1% bond MLPF&S rally (good diversification) would generate no selling pressure, underscoring the critical nleiselss erie PelMiseom role played by bond-equity correlation in governing the severity of risk parity unwinds. SSH peiets MLPF&S Europe stefano.pascale@baml.com Buy the seasonal oil dip via bullish X-market risk reversals Steet Selling rich USO (WTI tracker) 3M 25d puts to fund cheaper SXEP (European Oil & Gas ee equity) calls is historically attractive. Indeed the number (>2) of long SXEP calls per short ; ; dis >> , we is n 5 ason Galazidis USO put is in the 90" %-ile since 2008. The trade leverages both our commodity Equity-Linked Analys strategists’ ‘buy the dip’ view and our equity strategists’ bullish outlook on the Oil & Gas en ee : . jason.galazidis@baml.com sector, which has been the worst performing over the last 1M. Moreover, the average festul Guna ss payoff of being long SXEP 3M 25d calls would have been >2x greater than USO 3M 25d Equi elated Analys calls (owing to more frequent positive returns), when sized for the same upfront cost. LSS clea aa i Abhinandan Deb >> Asia Eauity-Linked Ana ysl Own NKY Sep/Oct calendar call at vol hit YTD low level going into the Sep BO) MEO ‘ : abhinandan.deb@baml.com Post the Jul-16 Bo) and the announcement of a ¥28.1tn fiscal stimulus package, NKY and Senianin Bowler USDJPY 1M vols have dropped to near YTD low levels, both USDJPY and NKY 2M-1M Equity Linked Analys
MLPF&S
term structures are historically steep, pricing in a slow summer. Our strategists believe Hera inBewleraisamieant
Sep-16 Bo)’s will likely create uncertainty, however, NKY Sep-Oct ATM fwd vol currently trades at the low end of its trading range going into Bo)’s YTD. Plus, our analysis
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2 suggests a further squeeze in yield will likely be positive for the NKY. We recommend Table 1: 3M volatility (weekly changes) 2 buying 1x NKY Oct 17500 call vs. selling 0.65x Sep 17250 call. Implied Realized Trade update: Closing the NKY Aug/Sep put calendar trade at 0.28% premium S8&P500 19 (07 13.2(-0.1 3 ; ; ; oo ; ESTX50 92(06) 27.704) 3 Korean auto-callable issuance slightly rose while NKY Uridashi issuance fell in July FTSE 26(-07 18.9 (0.1) 2 DAX 78(-1.1 24.6 (-0.1 8 NKY 21.7 (-1.1 27.2 (-12 z HSI 75(0.6) 17.2(-05 - KOSPI 2.6 (-0.4 12.9 (0.5) 2 EEM US 88 (08) 22.1(-09 & TOP40 19.4 (03) 18.1 (0.4 RDX 28.2 (-1.6 25.8 (-0.6 e IBOV 217(00) 21 7(07 = ISE30 29.9 (-0.1 27.7 (-04 5 Source: BofA Merrill Lynch Global Research
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