Bank of America Merrill Lynch Equity Derivatives Research Note (June 2017)

Unauthorized redistribution of this report is prohibited. This report is intended for [email protected] Global Equity Volatility Insights Want a cheap call on EU equity? Monetise correlation through EU bank dispersion 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 7Obps (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 (13 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. >> Employed by a non-US affiliate of MLPF&S and is not registered/qualified as a research analyst under the FINRA rules. Refer to "Other Important Disclosures" for information on certain BofA Merrill Lynch entities that take responsibility for this report in particular jurisdictions. BofA Merrill Lynch does and seeks to do business with issuers covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Refer to important disclosures on page 28 to 29. Analyst Certification on page 27. 11756528 Timestamp: 20 June 2017 01:18AM EDT Bankof America Merrill Lynch 20) une 2017 Equity Derivatives Glob. al BofA Analytics = DATA DRIVEN = Global Equity Derivatives Rsch MLPI F&S Anshul Gupta >> Equi MLI Nitin Saksena Equi MLP Willi Equi ‘y-Linked Analys UK) y-Linked Analys F&S am Chan, CFA >> y-Linked Analys Merrill Lynch (Hong Kong) Abhi Equi MLI Benj Equi MLP nandan Deb >> ‘y-Linked Analys UK) amin Bowler ‘y-Linked Analys F&S [email protected] Jason Galazidis >> Equi MLI Clov Equi MLI Chin Equi MLP Michael Youngworth Equi MLP Nikolay Angeloff Equi MLP y-Linked Analys UK) is Couasnon >> y-Linked Analys UK) tan Kotecha y-Linked Analys F&S ‘y-Linked Analys F&S y-Linked Analys F&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 3.4 (0.3) 1.5 (0.2) FTSE 10.0 (-0.4) 9.7 (0.2) DAX 2.6 (0.3) 0.7 (0.5) NKY 13.8 (-0.2) 12.3 (-0.2) HSI 24 (0.1) 0.1 (0.2) KOSPI 2.2 (0.3) 0.5 (0.1) EEM US 5.6 (0.5) 11.8 (-1.1) TOP40 6.9 (1.2) 1.1 (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) 3.5 (0.1) Source: BofA Merrill Lynch Global Research H OUSE_OVERSIGHT_014972