RE: Cheap hedge

While we are still constructive equities and see further upside potential, given the large recent moves and our binary view of the markets for 2017 (+20% bull case / -30% bear case - see below), buying cheap tail protection to hedge a long equity portfolio is prudent.

You can achieve significant savings on a tail hedge by monetizing the low correlations between sectors that we have seen in the multi-year bull market. In a tail event, correlations generally move towards 1 as you know very well.

Buy a best-of-put on 3 sectors: tech, consumer discretionary and utilities

• Underlying ETFs: XLK (Tech Selector Sector SPDR), XLY (Consumer Discretionary Select Sector SPDR), XLU (Utilities Select Sector SPDR)

• Your payoff is on the best performing of the 3 sectors

• 95% strike

6 months: 1.0% premium

1 year: 1.85% premium

This is - 64% savings compared to a 6 month SPX 95% put (2.75%) and a 1 year SPX 95% put (5.1%)

We like the best-of-put because all three sectors are near cycle or all-time highs and should all be vulnerable in a large market pullback, especially in a tail event. Even utilities, a defensive sector, are less safe in our view given elevated valuations and crowding. Our utilities analyst sees 10% downside to the sector with the 10y at these levels (2.62% today) and 16.7% downside at 3.0%.

There is a high amount of potential leverage on this trade — for example, on the 1 year best-of-put, if the sectors were all down > 20%, you would have 8.1x payoff on your premium (15%/1.85%).

US Equity Strategy Year Ahead: 2017 – the year ahead: Euphoria or fiscal fizzle?

Savita Subramanian thinks 2017 could be anything but normal — Subramanian notes that if the market moves from skepticism to euphoria then the S&P 500 could trade as high as 2700 in a bull case scenario. Meanwhile, applying typical (not extreme) recessionary returns to current S&P 500 levels yields a bear case scenario of 1600. Her base case is a year-end 2017 S&P500 target of 2300.

10 Year Graph: XLY, XLIC, XLU

Source: Bloomberg

Regards,

Amanda

Amanda Ens

Director

I wanted to follow up on the best-of-put idea we discussed a while back.

1. Markets are near all-time highs

2. Implied volatility is low (but tends to pick up in a sell-off, benefitting this trade)

3. Implied correlation is low (but tends to pick up in a sell-off, benefitting this trade)

Best-of-puts thus look very attractive.

Given high client interest recently in best-of-puts, here is a list of the top 10 lowest premium strategies for 6 month 95% best-of-puts struck on 3 sector ETF underlyings.

ETF underlyings + premium:

XLB .1

XLU .1

XLV .1

0.93%

XLB .1

XLU .1

XLY .1

0.99%

XLB .1

XLK .1

XLU .1

1

1.00%

XLE .1

XLU .1

XLV .1

1.00%

XLU .1

XLV .1

XLY .1

1.01%

XLB .1

XLF .1

XLU .1

1.04%

XLK .1

XLU .1

XLV .1

1.04%

XLI .1

XLU .1

XLV .1

1.05%

XLE .1

XLK .1

XLU .1

1.06%

XLF .1