File 025978
Global Equity Volatility Insights and Risk Parity Analysis (File 025978)
Bank of America Merrill Lynch equity derivatives research report analyzing global equity volatility, risk parity fund dynamics, and cross-asset trading strategies as of August 9, 2016.
Summary
This BofA Merrill Lynch Global Equity Derivatives research report dated August 9, 2016, examines global equity volatility trends and risk parity fund behavior following market turmoil in Japanese Government Bond markets. The report provides quantitative analysis of bond-equity correlation risks, scenario modeling for risk parity deleveraging triggers, and trading recommendations across US, European, and Asian equity markets. It includes detailed volatility metrics for major indices (S&P 500, DAX, Nikkei, etc.) and discusses the BofAML Global Financial Stress Index, which reached new year-to-date lows following the Bank of England rate cut and positive US employment data.
Global Equity Volatility InsightsUnderstanding when risk parity riskincreaseswe estimate 68% of the09 August 2016 CorrectedUnauthorized redistribution of this report is prohibited. This report is intended for amanda.ens@baml.comUSQuantifying the (bond-equity correlation) risks to risk parityLast week’s sharp sell-off in JGBs renewed concerns of forced selling by risk parityfunds. While the drawdowns in US Treasuries, US equities, and ultimately risk parityportfolios 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) bondallocations are historically elevated, and (iii) markets continue to be sceptical of a 2016Fed hike. Hence we provide a simple scenario tool to help investors assess what relativemoves in bonds and equities could catalyse significant deleveraging by rules-based riskparity funds running vol target overlays. For example, a -2% daily decline in the S&P500 coupled with a -0.6% fall in 10y Treasury prices (poor diversification) could trigger a25% deleveraging (of unlevered notional) today, whereas a -4% SPX drop and +1% bondrally (good diversification) would generate no selling pressure, underscoring the criticalrole played by bond-equity correlation in governing the severity of risk parity unwinds.EuropeBuy the seasonal oil dip via bullish X-market risk reversalsSelling rich USO (WTI tracker) 3M 25d puts to fund cheaper SXEP (European Oil & Gasequity) calls is historically attractive. Indeed the number (>2) of long SXEP calls per shortUSO put is in the 90 th %-ile since 2008. The trade leverages both our commoditystrategists’ ‘buy the dip’ view and our equity strategists’ bullish outlook on the Oil & Gassector, which has been the worst performing over the last 1M. Moreover, the averagepayoff of being long SXEP 3M 25d calls would have been >2x greater than USO 3M 25dcalls (owing to more frequent positive returns), when sized for the same upfront cost.AsiaOwn NKY Sep/Oct calendar call at vol hit YTD low level going into the Sep BOJPost the Jul-16 BoJ and the announcement of a ¥28.1tn fiscal stimulus package, NKY andUSDJPY 1M vols have dropped to near YTD low levels, both USDJPY and NKY 2M-1Mterm structures are historically steep, pricing in a slow summer. Our strategists believeSep-16 BoJ’s will likely create uncertainty, however, NKY Sep-Oct ATM fwd vol currentlytrades at the low end of its trading range going into BoJ’s YTD. Plus, our analysissuggests a further squeeze in yield will likely be positive for the NKY. We recommendbuying 1x NKY Oct 17500 call vs. selling 0.65x Sep 17250 call.Trade update: Closing the NKY Aug/Sep put calendar trade at 0.28% premiumKorean auto-callable issuance slightly rose while NKY Uridashi issuance fell in July>> Employed by a non-US affiliate of MLPF&S and is not registered/qualified as a research analyst underthe FINRA rules.Refer to "Other Important Disclosures" for information on certain BofA Merrill Lynch entities that takeresponsibility for this report in particular jurisdictions.BofA Merrill Lynch does and seeks to do business with issuers covered in its research reports. As aresult, investors should be aware that the firm may have a conflict of interest that could affect theobjectivity of this report. Investors should consider this report as only a single factor in makingtheir investment decision.Refer to important disclosures on page 25 to 26. Analyst Certification on page 23. 11657850Equity DerivativesGlobalGlobal Equity Derivatives RschMLPF&SChintan KotechaEquity-Linked AnalystMLPF&Schintan.kotecha@baml.comNitin SaksenaEquity-Linked AnalystMLPF&Snitin.saksena@baml.comStefano PascaleEquity-Linked AnalystMLPF&Sstefano.pascale@baml.comWilliam Chan, CFA >>Equity-Linked AnalystMerrill Lynch (Hong Kong)william.w.chan@baml.comJason Galazidis >>Equity-Linked AnalystMLI (UK)jason.galazidis@baml.comAnshul Gupta >>Equity-Linked AnalystMLI (UK)agupta113@baml.comAbhinandan Deb >>Equity-Linked AnalystMLI (UK)abhinandan.deb@baml.comBenjamin BowlerEquity-Linked AnalystMLPF&Sbenjamin.bowler@baml.comSee Team Page for Full List of ContributorsTable 1: 3M volatility (weekly changes)Implied RealizedS&P500 11.9 (-0.7) 13.2 (-0.1)ESTX50 19.2 (-0.6) 27.7 (0.4)FTSE 12.6 (-0.7) 18.9 (0.1)DAX 17.8 (-1.1) 24.6 (-0.1)NKY 21.7 (-1.1) 27.2 (-1.2)HSI 17.5 (-0.6) 17.2 (-0.5)KOSPI 12.6 (-0.4) 12.9 (0.5)EEM US 18.8 (-0.8) 22.1 (-0.9)TOP40 19.4 (0.3) 18.1 (-0.4)RDX 28.2 (-1.6) 25.8 (-0.6)IBOV 21.7 (0.0) 21.7 (-0.7)ISE30 29.9 (-0.1) 27.7 (-0.4)Source: BofA Merrill Lynch Global ResearchBofAML GFSI TM X-Asset Risk LandscapeGFSI makes new YTD lows as BoE & NFP boost risk assetsThe GFSI declined to a new YTD low of 0.18 as of 5-Aug, a level not seen since Nov-15.With the BoE surprising to the upside in terms of cutting rates, re-starting QE andguiding towards more accommodative policy down the line, as well as better thanexpected US non-farm payrolls, risk assets globally got a boost.• Credit experienced the biggest decline in stress across assets: Chart 3shows that credit (followed by equities) experienced the biggest weekly stressdecline. Indeed, Chart 5 and Chart 6 show that sovereign risk as measured by IG& sub-IG foreign sovereign bond spreads experienced the most significantweekly declines in stress versus their history in the GFSI.• Europe continues to be most stressed region: Chart 4 shows that Europe isthe most stressed region in the GFSI, despite the stress declines last week. USrelatedstresses which were already relatively lower vs the other regions, weremore resilient. Indeed the only significant move higher in regional stress was inUSD Libor-OIS spreads (Chart 5), which our Rates strategists view as driven bythe anticipation of US money market mutual fund reform in October..Chart 1: Latest* stress across GFSI sub-components4.03.0Red shaded area highlights components in BearishGFSI Stress2.01.00.0-1.0-2.03.50Basis Swap USDJPY1.78Basis Swap EURUSD1.611.24Govt-OIS EURBond Basis EUR0.92CDS Index Skew USDEuro member Bond…USDJPY Imp VolLibor-OIS USDComdty Imp Vol CrudeESTX50 SkewSP500 SkewNikkei SkewUSDJPY SkewGBPUSD Imp VolGovt-OIS USDEURJPY SkewLibor-OIS GBPVolume FlowHY Bond FlowCDS Index Skew EURBond Basis USDIG Foreign Sovrn Bond…AUDJPY SkewEquity Fund Flow EMNikkei Imp VolHY Corp CDS USDLibor-OIS EURESTX50 Imp VolRiskSkewFlowSub IG Foreign Sovrn…HSI Imp VolLibor-OIS JPYGreen shaded area highlights components inBullish territoryIG Corp CDS USDHY Corp CDS EURComdty Imp Vol GoldIG Corp CDS EURFTSE Imp VolMoney Mkt FlowComdty Imp Vol Copper-0.733Y/5Y Credit Curve EUR-0.77SP500 Imp Vol-0.81Int Rate Imp Vol USD-0.82EURUSD Imp Vol-1.11Int Rate Imp Vol EURSource: BofA Merrill Lynch Global Research. *Latest as of 05-Aug-16Chart 2: Change** in stress across GFSI sub-components. The biggest moves were declines in stress; led by credit. Notably stress in GBP vol declined post BoE0.6Change in GFSI Stress0.2-0.2-0.6-1.00.26Volume Flow0.15EURJPY Skew0.130.11CDS Index Skew USDBasis Swap USDJPY0.10USDJPY SkewGovt-OIS EURInt Rate Imp Vol USDGovt-OIS USDComdty Imp Vol CopperSource: BofA Merrill Lynch Global Research. **Latest as of 05-Aug-16. Change vs 1 week prior (29-Jul-16).Libor-OIS USDUSDJPY Imp VolMoney Mkt FlowInt Rate Imp Vol EURHY Bond FlowComdty Imp Vol GoldHY Corp CDS USDHY Corp CDS EUR3Y/5Y Credit Curve EURIG Corp CDS EURComdty Imp Vol CrudeEuro member Bond…IG Corp CDS USDBond Basis USDEquity Fund Flow EMEURUSD Imp VolHSI Imp VolLibor-OIS JPYLibor-OIS EURESTX50 SkewAUDJPY SkewESTX50 Imp VolFTSE Imp VolSP500 Imp VolNikkei SkewSP500 SkewBasis Swap EURUSDNikkei Imp VolLibor-OIS GBP-0.22Sub IG Foreign Sovrn…-0.23GBPUSD Imp Vol-0.25-0.43Bond Basis EURIG Foreign Sovrn Bond…-0.63CDS Index Skew EUR2 Global Equity Volatility Insights | 09 August 2016The GFSI Risk Allocator favours being underweight risk assets given the distribution ofstresses within the GFSI. The percentages of Bullish, Bearish and Neutral GFSIcomponents (as used in the Risk Allocator) were 8.7%, 13.0% & 78.3%, respectively asof 5-Aug. The Risk Allocator (using Bull, Bear & Neutral weights of 2, 0, 1) suggestsreducing the underweight position to 4.3% UW from last week’s 17.4% UW.Chart 3: Stress across assets (Rates & FX are the most stressed assetclasses – credit stress declined the most last weekChart 4: Stress across regions (Europe is the most stressed region in theGFSI while EM is the least stressed)0.60.50.40.30.20.10.0-0.1-0.20.01-0.01 -0.01 -0.05-0.12Commodities Rates FX Equities Credit0.10.10.0-0.1-0.1-0.20.03-0.11 -0.11 -0.11US Japan Europe EMLatest stress (05-Aug-16)Change in stressLatest stress (05-Aug-16)Change in stressSource: BofA Merrill Lynch Global Research. 1wk change (22-Jul-16 to 29-Jul-16).Source: BofA Merrill Lynch Global Research. 1wk change (22-Jul-16 to 29-Jul-16).Chart 5: Top 10 movers in stress (1-week abs chg %-ile vs history*)Stress fallStress rise100% 99%100%95% 93%90%85%81% 80% 78% 77%80%69%70%%-ile of abs chg in stress vs history*60%50%IG Foreign SovrnBond SpreadSub IG ForeignSovrn Bond…Libor-OIS GBPCDS Index SkewEURGBPUSD Imp VolLibor-OIS JPYComdty Imp VolCopperBasis SwapEURUSDLibor-OIS USDLibor-OIS EURChart 6: Global volatility & credit spread stress in the GFSI0.40.20.0-0.2-0.4-0.6-0.8-1.0-1.2Latest stress (05-Aug-16)0.04 0.01Rates VolCommodity VolHY CDS-0.01 -0.03IG CDSChange in stressFX Vol-0.08 -0.10Equity Vol-0.23Sovrn riskSource: BofA Merrill Lynch Global Research. * %-ile of weekly move in stress vs all historical weeklymoves (earliest 3-Jan-00). Bar colours represent rise (red) or fall (green) in stress. 1wk change (22-Jul-16 to 29-Jul-16).Source: BofA Merrill Lynch Global Research. 1wk change (22-Jul-16 to 29-Jul-16).Global Equity Volatility Insights | 09 August 2016 3Volatility in the USQuantifying the (bond-equity correl) risks to risk parityLast week’s sharp sell-off in JGBs (Chart 7) following the BoJ’s decision not to cut ratesrenewed investor fears of forced selling by risk parity funds. However, the spill-overinto US Treasuries was relatively muted (Chart 7), and coupled with a small and fleetingdrawdown in US equities, risk parity portfolio volatility failed to rise materially (Chart 8).Consequently, risk parity funds were likely forced to unwind little to none of theirleverage last week and remain near max leverage levels (Chart 9).For this very reason, the latent risk in this corner of the quant fund space remains worthmonitoring. Furthermore, as we noted post-Brexit, fixed income allocations within riskparity funds are historically elevated today. And with federal-funds futures marketsimplying a ~25% chance of a Sep rate hike and less than a 50% probability of a Dechike, bond markets may be surprised by a 2016 Fed hike.Chart 7: Last week’s sharp sell-off in JGBs didnot spill-over into US Treasuries10410310210110099Jan-16 Apr-16 Jul-1610y JGB futures total return1081061041021009810y UST futures total return (right)Source: BofA Merrill Lynch Global Research. Daily data from 4-Jan-16 through 5-Aug-16.Chart 8: Consequently, risk parity portfoliovolatility remained quite muted10%9%8%7%6%5%4%3%2%Aug-12Aug-13Aug-14Aug-15Aug-16Historical volatility of unlevered riskparity portfolioSource: BofA Merrill Lynch Global Research. Equity, fixed income,and commodity components within the hypothetical risk parityinvestment are represented by the S&P500, 10-Year US TreasuryBonds, and the S&P GSCI Index respectively. Risk parityallocations are determined and rebalanced monthly using prior12-month realized volatility and correlations. Historical volatilitycalculated using EWMA with a lambda equal to 0.94.Chart 9: Hence risk parity funds did not delevermaterially and remain highly levered32.521.510.5Dec-12 Dec-13 Dec-14 Dec-15LOW Vol Target (6%) & Lvg (1.5x)MEDIUM Vol Target (8%) & Lvg (2x)HIGH Vol Target (10%) & Lvg (3x)Source: BofA Merrill Lynch Global Research. Daily data from 31-Dec-12 through 27-Jun-16. Equity, fixed income, and commoditycomponents within the hypothetical risk parity investment arerepresented by the S&P500, 10-Year US Treasury Bonds, and theS&P GSCI Index, respectively. Risk parity allocations aredetermined and rebalanced monthly using prior 12-monthrealized volatility and correlations.Monitoring relative equity/bond moves for potential risk parity deleveragingIt is intuitive to think that rising volatility corresponds to an increase in model-drivenselling pressure from risk parity strategies. However, what’s less appreciated in ourview is the impact on risk parity allocations as a result of the relative dynamicsbetween component volatilities and correlation. For example, through the close on theMonday post-Brexit (27-Jun-16), S&P 500 volatility rose from 9.6% two days prior to17.9% (increase of 1.9x) while 10-Year US Treasury Futures return volatility rose 4.3%to 6.6% (increase of 1.5x). Despite these outsized vol moves, in a recent report weshowed that owing to the diversification (increasingly negative correlation) betweenequities and bonds, unlevered risk parity portfolio volatility remained stable and hence,target vol overlays were less likely to be subject to model-driven selling.Given low levels of realized volatility across asset classes, it’s also intuitive to expectcontinued elevated levels of leverage in risk parity products. To the extent that theleverage is via vol control overlays, there are reasonable concerns on the potentialmarket impact should these model-driven investments be forced to simultaneouslydeleverage. To that end, we provide a simple scenario tool (Chart 10) to help investorsassess what relative moves in the S&P 500 and 10-year US Treasury futures couldcatalyze significant deleveraging by rules-based, vol-controlled risk parity funds.4 Global Equity Volatility Insights | 09 August 2016Importantly, this scenario tool is a function of (1) current unlevered risk parity volatility,(2) current risk parity component weights, and (3) the maximum leverage of the targetvolatility overlay. For simplicity, we used only a two asset risk parity portfolio of equityand fixed income applied to the S&P 500 and 10-Year US Treasury Futures.Chart 10: Current theoretical deleveraging amounts (of unlevered notional) for an equity/fixedincome risk parity portfolio with an 8% target volatility overlay and 2x max leverage capAssumes a trailing unlevered volatility of 3.1%, unlevered equity and fixed income weights of 22% and 78% respectively,and leverage at a maximum of 2.0 times5%Daily 10-year USD Treasury Futures Total Return4%3%2%1%0%-1%-2%-3%-4%BrexitAug-15 Risk FlareTaper Tantrum-5%-5% -4% -3% -2% -1% 0% 1% 2% 3% 4% 5%Daily S&P 500 Total Return> 50% Delever 50% to 25% Delever 25% to 0% Delever No DeleverSource: BofA Merrill Lynch Global Research. Data as of 5-Aug-16. Equity and fixed income components within the theoretical risk parityinvestment are represented by S&P 500 total return and 10-Year US Treasury Futures total return. Risk parity allocations are determinedmonthly and rebalanced using prior 12-month realized volatility. Unlevered portfolio volatility for determining target volatility leveragemeasured using EWMA with lambda equal to 0.94.For example, last Friday 10-Year US Treasury futures declined about 60bps. Had theS&P 500 declined 2.0%, we would have expected about 25% of the unlevered notionalof a model 8% vol-targeted, 2.0x max leverage risk parity portfolio to deleverage. TheS&P 500 was in fact up 86bps on a total return basis which according to the tool falls inthe region of no deleveraging.Also, to put recent events in perspective, we plotted on the scenario tool the respectivemoves in the S&P 500 and 10-Year US Treasury futures during the Taper Tantrum (19-Jun-2013), the Aug-15 risk flare (24-Aug-15), and post-Brexit (24-Jun-2016). Note, foran accurate assessment through those events, we would also need to reconfigure thescenario tool for the respective unlevered risk parity volatility and risk parity componentweights on those dates. However, with current measures for both, the tool doesestimate current deleveraging flows should we see similar equity and bond moves today.Interestingly, equity/bond moves through the Aug-15 risk flare would not cause adeleveraging today. The reason is bonds have increased in allocation since last August(78% vs. 66%), and hence the portfolio is more resilient towards equity market declines(but consequently also more sensitive to fixed income declines).The scenario tool also underscores impact on risk parity leverage as a result of therelative dynamics between component volatility and correlation. For example, the firstand third quadrants (upper right and lower left sections) are dominated by scenarios ofgreater than 50% deleveraging. On the other hand, the second and fourth quadrantsGlobal Equity Volatility Insights | 09 August 2016 5have episodes of more benign model-driven deleveraging. In each quadrant existsexamples of simultaneously increasing equity and bond volatility (that is, high absoluteequity and bond daily returns). However, in the first and third quadrant, equity and bondmoves are in the same direction, which would likely be an example of increasingcorrelation. On the other hand, in the second and fourth quadrant equity and bondmoves are in opposite directions and hence correlation is subject to a decrease. Themain takeaway here is the most risk of model driven deleveraging from vol controlledrisk parity funds comes when both volatility and correlation of the underlyingcomponents rise together.6 Global Equity Volatility Insights | 09 August 2016Week in review & notable trends (US)US equities at new all-time highs on upbeat employment reportBoth the S&P500 and NASDAQ finished the week higher marking fresh all-time highs asthe July nonfarm payrolls and average hourly earnings came in better-than-expected. Asa result, VIX fell to its lowest levels since Jul-14 and the SPX 1y vs. 1m ATMf implied volspread rose to its highest level in almost four years on lower short dated vol.Across other asset classes, the USD finished with gains against other major currencies,while Treasury yields rose across the curve, which partly explained the outperformance(underperformance) in Financials (Utilities) (i.e., +1.7% and -2.7%, respectively).Most companies (86% as of 5-Aug) in the SPX have reported Q2 results and the blended(actual + estimated) yoy earnings decline for Q2-2016 now stands at -3.5%, less thanthe expected decline of -5.5% as of 30-Jun. Analysts expect CY16 earnings decline of -0.3% which would mark the first time SPX has reported two consecutive years ofearnings decline since 2008. Earnings growth is now expected to resume in Q4-16.Chart 11: The SPX vol term-structure steepened materially on lowershorter dated implied vol with the 1yr-1m ATMf implied vol spreadreaching its highest level in almost 4 years30%25%20%15%10%5%0%-5%Aug-12Nov-12Feb-13May-13Aug-13Nov-13Feb-14May-14Spread A - BSPX 1yr ATMf implied vol (A)SPX 1m ATMf implied vol (B)Source: BofA Merrill Lynch Global Research. Daily data from 8-Aug-12 to 8-Aug-16.Aug-14Nov-14Feb-15May-15Aug-15Nov-15Feb-16May-16Aug-16With SPX rallying on a stronger-than-expected July jobs report,SPX implied vol took a further leg down, especially in theshorter end of the vol curve. Indeed, SPX 1m ATMf implied volended the week at 9.1 vol pts, within striking distance of its 2-year lows.On the other hand, longer dated ATMf implied vols did not fallnearly as much causing a material steepening in the vol termstructure. For instance, the 1yr-1m implied vol spread reachedits highest level since 27-Sep-12 (6.4 vol pts).Chart 12: Near multi-year flat call skew on Biotech (IBB) makes long callspreads an attractive option strategy to initiate or replace long positionsto lock-in profits from the recent strong rally55%20.0%50%45%40%17.5%15.0%35% 45th %-ile12.5%30%25%10.0%20%7.5%15%10%5%5.0%2.5%0%0.0%2011 2012 2013 2014 2015 20165-day MA of spread A - B (RHS)IBB 1M ATMf implied vol (A)IBB 1M 110 implied vol (B)Source: BofA Merrill Lynch Global Research. Daily data from 5-Aug-11 to 5-Aug-16.Since its peak in Jul-15, the Biotech sector (NBI Index) has beenon one of its worst runs in decades, underperforming the broadmarket benchmark (SPX) by a whopping ~30% on a total returnbasis. However, more recently the sector has regained somelost ground on solid large-cap earnings reports (i.e., +13.2%since 1-Jul, 9.3% above the SPX).While short-dated implied vol has dropped considerably as aconsequence of the recent rally, it still remains supported on a5-yr basis. Also, upside vol has been richening vs. ATM vol, withthe 1m IBB ATM-110 implied vol spread reaching its lowestlevel in five years on 4-Aug and finishing the week at 1.2 vol pts(3 rd 5-yr %-ile).Investors with a constructive view on the sector who areconcerned about a reversal of the recent gains should considerreplacing or initiating long position via short dated ATM callspartially financed by expensive OTM calls.Global Equity Volatility Insights | 09 August 2016 7Chart 13: The 2016 election move implied by the VIX term structure is,in our estimate*, approx. 1.4%...Interpolated Oct future (level where Sep/Oct/Nov Fly = 0)Expected Oct future based on median level of ~1M/2M/3M flyVIX futures (adjusted for holidays)18.117.917.617.417.116.916.616.416.115.915.615.415.114.914.6Excess vol vsmedian levelsImplied daily move on electionday = 1.4% vs. a typical realized''election day" move of 1.5% (seeChart 14)Sep16 Oct16 Nov16Source: BofA Merrill Lynch Global Research. Daily data from 2-Jun-09 to 5-Aug-16. *Day countadjustment = we adjust the VIX futures curve to reflect the Trade-Day/252 day-count convention anduse SQRT ((30/365*252/T)) as the adjustment factor to convert to the common day-countconvention used in variance swaps. Term-structure adjustment = we add the median level of the daycountadjusted generic 1m/2m/3m fly (i.e. -0.5x Sep fut. +1xOct fut. -0.5x Nov fut.) to take intoaccount the usual VIX term structure.Using the VIX term structure in the Sep/Oct/Nov buckets andadjusting for term structure/day convention (see footnote toChart 13), we estimate the option markets’ implied move over asingle day in the Oct-Nov period (which encompasses the USelection on 8-Nov).Our estimated implied move is 1.4% which is notably very closeto the typical 1-day post-election day SPX realized move overpast election cycles (1.5% since 1928) (see Chart 14).Importantly, there is a larger-than-typical variation in thedistribution of all daily post-election SPX returns (34.0 vol ptsvs. 18.4 vol pts for daily SPX returns since Jan-1928), with thelargest and the fourth largest daily post-election SPX returnssince 1928 occurring in the last two election cycles alone (seeChart 14).Chart 14: …which is notably very close to the typical SPX daily realizedmove post-elections since 19286.0%5.0%4.0%3.0%2.0%Implied move around 2016election day (see Chart 13)Hence, investors who believe this is not your typical election (toquote President Obama at the latest Democratic NationalConvention) may still find that option markets are currentlypricing too little of a move.However, as we have recently argued the debate about whethera Trump win would be good or bad for markets coupled with theinability to exactly pinpoint real risks are likely headwinds to asizeable market shock.1.0%0.0%6-Nov-288-Nov-323-Nov-365-Nov-407-Nov-442-Nov-484-Nov-526-Nov-568-Nov-603-Nov-645-Nov-687-Nov-722-Nov-764-Nov-806-Nov-848-Nov-883-Nov-925-Nov-967-Nov-002-Nov-044-Nov-086-Nov-128-Nov-16Abs. post election day SPX realized move Average from 1928 to 2012Source: BofA Merrill Lynch Global Research. Data from Nov-28 to Aug-16.8 Global Equity Volatility Insights | 09 August 2016Table 2: Current S&P500 volatility and correlation measures relative to the prior two year of historical daily data1-week changeOver 2-year historical period5-Aug-16 29-Jul-16 ChangeCurrentrankingMinimum 25% Median 75% Maximum1-month ATM implied volatility 9.1% 9.9% -0.8% 0.1% 9.0% 11.2% 12.7% 15.4% 31.8%1-year ATM implied volatility 15.4% 16.0% -0.6% 13.1% 14.4% 15.8% 16.5% 17.6% 22.5%1-week intraday realized volatility 8.6% 9.9% -1.3% 11.5% 6.1% 10.1% 12.1% 16.4% 53.7%1-year minus 1-month term structure 6.4% 6.1% 0.3% 100.0% -12.0% 2.1% 3.7% 4.6% 6.4%3-month 90 minus 110 skew 9.5% 9.6% -0.1% 3.1% 9.1% 11.1% 11.5% 11.9% 13.8%1-year top 50 implied correlation 50.31 55.08 -4.77 3.3% 48.38 53.81 55.57 57.90 67.893-month top 50 realized correlation 47.71 51.08 -3.38 74.9% 25.85 33.29 39.89 47.71 60.41VIX 1-month ATMf implied vol 82.6% 88.8% -6.2% 40.3% 62.1% 77.4% 86.1% 98.1% 162.2%VIX 1-month 110 minus 90 skew 20.0% 22.2% -2.2% 39.7% 9.3% 17.9% 20.9% 23.9% 30.3%Source: BofA Merrill Lynch Global ResearchGlobal Equity Volatility Insights | 09 August 2016 9Volatility in EuropeBuy the seasonal oil dip via bullish X-market risk reversalsLevered X-market risk reversal: Sell 1x USO 3M 25d (~88% strike) putsto fully fund 2.1x SXEP (Oil & Gas equity) 25d (~106% strike) calls (indic.)Alternative (unlevered) implementation: Sell USO 25d puts to fund fullyfund closer to the money SXEP callsThe seasonal sell-off in oil presents a ‘buy the dip’ opportunity according to ourcommodity strategists, who expect prices to rebound to $55/bbl by year end. In factcurrent levels of ~$40 are close to the summer floor ($39) they had previouslysuggested.BofAML strategists have turned bullish Oil & Gas equities given more CB (BoE)easing, attractive div yields and exposure to the EM recovery narrative. Moreover, Oil &Gas has been the worst performing Stoxx 600 sector over the last 1M, suggesting it hasample scope to rally if it is to catch up to the broader equity market (Chart 15).USO (Oil ETF) puts are rich vs. SXEP (European Oil & Gas equity) calls: The numberof long SXEP 25d calls that can be fully funded by selling 1 short USO 25d put is nearhistorical highs (90 th percentile since ’08, Chart 16). In contrast, both SXEP and USO riskreversals are only modestly more attractive than their historical medians.SXEP calls would have offered better value than USO calls at current levels in termsof average historical payoffs as well as the frequency of positive returns (when sized forthe same upfront cost, Chart 17). Note that an unlevered implementation of the tradeallows for early participation in any potential SXEP rally (as the SXEP call strike is nearthe money) while providing a ~12% buffer before incurring losses (at expiry) on theshort USO leg (Chart 18).CSPP has purchased an outsized proportion of Energy corporate bonds and this hasyet to feed through to equities according to our credit strategists (Chart 19): Thenumber of Energy corporate bonds bought by the ECB is approx. 45% of the totaleligible amount – the 3 rd highest proportion across all European sectors.Potential USO losses may be dampened if the recent $/Oil correlation persists:Since mid-2015 oil drawdowns have largely coincided with USD weakening (Chart 20).Chart 15: SXEP (Oil & Gas equity) has been the worst performing Stoxx600 sector over the last 1M20%1M Sector Performance15%10%5%0%-5%Source: BofA Merrill Lynch Global Research. Data from 7-Jul-16 to 5-Aug-16.SXXP returnSXAPSX8PSX7PSX86PSXPPSXFPSXIPSXOPSXNPSXTPSX4PSXRPSXMPSXKPSXQPSX6PSX3PSXDPSXEPChart 16: The leverage provided by the X-market risk reversal (longSXEP call / short USO put) is attractive from a historical standpoint2.52.01.51.0SXEP call vs.USO putSXEP callvs. putUSO callvs. put90%80%70%60%50%# of long 3M 25d calls per short 3M 25d put percentile of ratio (rhs)*Source: BofA Merrill Lynch Global Research. Data as of 5-Aug-16, using indicative mid prices.*Percentiles since Jan-08.10 Global Equity Volatility Insights | 09 August 2016Chart 17: SXEP calls would have generated a higher average payoff andmore frequent positive returns vs. USO calls (when sized for an upfrontcost equal to the current price of the USO 3M 25d put)60%50%40%30%20%10%Avg Payoff Freq of >02.1x SXEP 3M 25d calls: 2.9% 27%1.3x USO 3M 25d calls: 1.4% 10%0%'08 '09 '10 '11 '12 '13 '14 '15 '16SXEP Call PayoffUSO Call PayoffSource: BofA Merrill Lynch Global Research. Data from 1-Jan-16 to 5-Aug-16.Backtesting is hypothetical in nature and reflects application of the screen prior to its introduction. Itis not intended to be indicative of future performance.Chart 18: Selling the USO 25d put (~8.7 strike as of 5-Aug) to buy theSXEP 42d call (~280 strike as of 5-Aug) for ~0 provides early upsideparticipation and a ~12% downside buffer on the short USO put leg300290280270260250240230220Long SXEP call strike(unlevered implementation)Jan16Jan16Jan16Feb16Feb16Mar16Mar16Apr16Apr16May16May16Jun16Jun16Jul16Jul16Jul16SXEPShort USO put strikeUSO (rhs)Source: BofA Merrill Lynch Global Research. Data from 1-Jan-16 to 5-Aug-16. Backtesting ishypothetical in nature and reflects application of the screen prior to its introduction. It is notintended to be indicative of future performance.13121110987Chart 19: Number of bonds purchased by the ECB in their CSPPprogramme by sector140# Bonds Purchased120% of Eligible100806040200Source: BofA Merrill Lynch Global Research.55%45%35%25%15%Chart 20: Oil drawdowns have recently coincided with $ weakening70%50%30%10%-10%-30%Negative correlation would have helpeddampen potential USD losses on theshort USO put leg'07 '08 '09 '10 '11 '12 '13 '14 '15 '16USO vs. EURUSD correlation* Conditional on USO downSource: BofA Merrill Lynch Global Research. Data from 18-Apr-07 to 5-Aug-16.Global Equity Volatility Insights | 09 August 2016 11Week in review (Europe)The FTSE100 reached 13 months highs last week as the BOE exceeded marketexpectations by announcing a 25 bp rate cut (its first rate cut in 7yrs), a further £60bnof QE purchases (vs forecasted £50 bn) while also hinting at more potential stimulus inthe autumn. Unsurprisingly, GBPUSD fell further on the back of this. The better-thanexpectedUS nonfarm payrolls that beat all surveyed forecasts helped drive US marketsto new all-time closing highs also helped European equities rebound from a mid-weektrough. As a result, the V2X has retraced close to its 11 month lows as foreseeablecatalysts are behind us for a potentially quieter end to the summer.• Long dated ESTX50 var term structure is historically elevated; vol termstructure is not: The dislocation of 3y var convexity (var strike/ATMf volatility)vs that of 1y, which in itself is near extremes, is particularly striking• European issuance of ESTX50-linked structured products picked up in July:We estimate issuance of ~€120Mn/day in July, which compares to €5Mn dailyissuance in June and €55Mn daily issuance in 1H16 (excluding June).• The current vega outstanding in SX5E-linked products is €143Mn, which is inits 97 th percentile since Jan-14 (when our records begin). Moreover, this couldrise to as much as €169Mn if the SX5E rallied to 3280.Long-dated ESTX50 var term structure is steep; vol term structure is notDespite a significantly steep longer dated ESTX50 variance term structure (vs itsaverage since 2008), the volatility term structure is nearly flat. As a result, the level ofESTX50 long dated variance is historically elevated vs the level of long dated vol. Thedislocation of 3y var convexity (varswap strike/ATMf vol ratio) vs 1y var convexity (whichin itself is near its historic highs) is particularly striking.Chart 21: Longer dated ESTX50 variance term structure is significantlyelevated vs long term average – the extreme steepness is not mirroredin the ATMf volatility term structure30%28%26%24%22%20%18%16%1m2m3m6m 1y 2y 3yvol surface - CurrentSX5Evar surface - Currentvol surface - Avg since 2008 var surface - Avg since 2008Source: BofA Merrill Lynch Global Research. Data: 02-Jan-08 to 5-Aug-16. Current representssnapshot as of 5-Aug-16Chart 22: ESTX50 variance convexity (varswap strike/ATMf vol ratio) isnear extremes – the dislocation of 3y var convexity vs that of 1y, whichin itself is near extremes, is particularly striking1.401.351.301.251.201.151.101.051.00Jan-0899.7 percentile96.1 percentileAug-08Mar-09Oct-09May-10Dec-10Jul-11SX5E 1y var convexityFeb-12Sep-12Apr-13Nov-13Source: BofA Merrill Lynch Global Research. Data: 02-Jan-08 to 5-Aug-16.Jun-14Jan-15Aug-15Mar-16SX5E 3y var convexityStructured product Jul update: EU issuance picked up; Korean issuance laggedWe estimate issuance of ESTX50-linked structured products in Europe was~€120Mn/day in July, much higher than the €5Mn daily issuance in June and €55Mn dailyissuance in 1H16 (excluding June). This compares to ~€20Mn daily issuance in July out ofKorea.12 Global Equity Volatility Insights | 09 August 2016Chart 23: European issuance of ESTX50-linked products rose to €9.9bnso far in 2016 (vs €7.2bn as of 4-Jul)EUR bn35302520151050Korea Europe 2016 annualised16.614.316.79.99.51.23.12013 2014 2015 2016Source: BofA Merrill Lynch Global Research. Data as of 4-Aug-1612.3Totalannualisedexpected: 20.5Chart 24: Issuance of ESTX50-linked structured products in Korea was inline with the 2016 issuance trendEUR bn2.52.01.51.00.50.0Jan-14Mar-14May-14Issuance of SX5E structured products in South KoreaRapid growth of SX5Eproducts in Koreanstructured marketJul-14Sep-14Nov-14Jan-15Mar-15May-15Jul-15Sep-15Source: BofA Merrill Lynch Global Research. Data as of 31-Jul-16Issuance sloweddown due toChina sell-off andnew localregulationsNov-15Jan-16Mar-16May-16Jul-16Current vega outstanding near at least 2.5y high as European issuance picks upWe estimate the current vega outstanding in SX5E-linked products (issued in Europeand Korea) sums up to €143Mn, which is in its 97 th percentile since Jan-14 (when ourrecords begin). Moreover, this could rise to as much as €169Mn if the SX5E rallies to3280 (assuming no net SX5E-linked issuance 1 , Chart 25, 26 and Chart 27).Chart 25: We estimate the current vega outstanding in SX5E-linkedstructured products is EUR 83Mn (European issuance) and EUR60Mn(Korean issuance)Vega (EUR Mn)120100806040200-20Max vega:EUR111mn at ~3400spot levelRef. spot = 2932Max vega:EUR61mn at ~3000spot level2000220024002600280030003200340036003800400042004400460048005000SX5E spot levelSource: BofA Merrill Lynch Global Research. Data as of 4-Aug-16Vega (Korean issuance)Vega (European issuance)Chart 26: The ESTX50 vega outstanding due to structured productsissuance could rise to EUR168Mn, assuming no new net issuanceVega (EUR Mn)180160140120100806040200-20Max vega:EUR168mn at ~3220spot levelRef. spot = 29322000220024002600280030003200340036003800400042004400460048005000SX5E spot levelSource: BofA Merrill Lynch Global Research. Data as of 4-Aug-16Vega (Aggregated issuance)1i.e. notional of newly issued structured products = notional of expiring structuredproductsGlobal Equity Volatility Insights | 09 August 2016 13Chart 27: The current vega outstanding in the ESTX50-linked structured products is EUR 143mn,which is in the 97 th percentile since 3-Jan-14EUR Mn160SX5E structured products vega notionalCurrent SX5E structured products vega notional outstanding14012097th percentile1008060Jan-14Mar-14May-14Jul-14Sep-14Nov-14Jan-15Mar-15May-15Jul-15Sep-15Nov-15Jan-16Mar-16May-16Jul-16Source: BofA Merrill Lynch Global Research. Data as of 4-Aug-16Table 3: Volatility measures of major equity indices in the EMEA region (data as of 05-Aug-16)3Mth ATM implied volatility 10D realised volatility 12Mth–3Mth ATM i-vol spread 3Mth 90-110 skewEquityindexWeeklyWeeklyWeeklyWeeklyWeeklyCurrent change 2Yr percentile Current change 2Yr percentile Current change 2Yr percentile Current change 2Yr percentile returnESTX50 19.2% -0.6% 31% 16.6% 5.6% 29% 1.0% 0.2% 87% 8.4% -0.1% 79% -0.6%FTSE 12.6% -0.7% 21% 10.9% 5.2% 29% 3.4% 0.5% 100% 7.5% 0.0% 10% 1.0%DAX 17.8% -1.1% 19% 13.6% 2.9% 11% 1.8% 0.4% 96% 8.6% -0.4% 78% 0.3%CAC 18.5% -0.7% 30% 15.4% 5.3% 27% 0.9% 0.3% 88% 8.6% 0.3% 86% -0.7%SMI 13.8% -1.2% 25% 14.5% 3.6% 51% 1.7% 0.6% 100% 7.6% -0.8% 57% 0.8%RDXUSD 28.2% -1.6% 6% 19.5% 9.2% 8% 1.1% 0.3% 89% 6.0% -0.1% 15% 1.7%TOP40 19.4% 0.3% 59% 11.1% 2.1% 19% 2.3% 0.1% 91% 8.7% -0.2% 63% -1.2%ISE30 29.9% -0.1% 96% 25.2% -21.6% 76% -0.9% 0.0% 7% 6.3% 0.1% 77% 1.0%Source: BofA Merrill Lynch Global ResearchEuropean volatility: Sector snapshotTable 4: Volatility measures and indicative option prices for major European sector indices (data as of 05-Aug-16)Bearish <<<< --------------------------------------------------- >>>> Bullish3Mth ATMf implied volatility Real vol* 3Mth 95%-85% put spread** 3Mth 100%-110% call spread**3Mth 90%-110% riskreversal**CurrentCurrentCurrentprice WeeklyMax price WeeklyMax price*** WeeklyWeekly 2Yr(% of change 2Yr payout (% of change 2Yr payout (% of change 2YrCurrent change %-ile Current spot) (bps) %-ile ratio spot) (bps) %-ile ratio spot) (bps) %-ileSX3P (Fd&Bv) 13.0% -2.7% 6% 12.9% 0.9% -27 15% 11.7 2.5% -18 19% 3.9 -0.5% -33 20% -0.5%SX6P (Utils) 16.4% -1.0% 32% 20.6% 1.2% -10 31% 8.3 3.0% -11 45% 3.3 -0.6% 0 22% -1.7%SX7E (Banks) 33.5% -2.3% 76% 48.0% 2.6% -13 82% 3.9 4.0% -7 75% 2.5 -0.5% 0 37% -1.8%SX7P (Banks) 28.2% -2.8% 75% 39.8% 2.2% -7 77% 4.6 3.8% -17 71% 2.7 -0.5% 17 35% 0.0%SXAP (Auto) 25.5% -1.1% 56% 33.4% 2.0% -7 52% 4.9 3.7% -8 64% 2.7 -0.6% 3 21% 0.6%SXDP (Health) 15.3% -0.5% 24% 12.7% 1.1% -5 27% 9.1 2.8% -7 35% 3.5 -0.4% 3 16% -0.9%SXEP (Oil&Gas) 23.5% -0.4% 44% 23.6% 1.9% -2 44% 5.4 3.6% -4 44% 2.8 -0.6% 3 28% -0.4%SXIP (Insur) 23.6% -0.4% 86% 31.7% 1.8% -2 84% 5.6 3.6% -3 88% 2.8 -0.6% 2 15% 0.8%SXKP (Telecom) 22.4% -0.2% 81% 23.4% 1.7% -1 75% 5.9 3.6% -2 87% 2.8 -0.7% 1 7% 0.5%SXNP (Indust) 21.5% 0.0% 67% 21.9% 1.7% 0 71% 5.8 3.4% 0 66% 2.9 -0.4% 1 74% 0.2%SXPP (Basic) 32.4% -1.6% 53% 29.7% 2.5% -7 53% 3.9 3.9% -5 59% 2.5 -0.4% 2 8% 1.3%SXQP (Prsnl&HH Gds) 15.4% 0.0% 33% 16.9% 1.0% 0 25% 9.7 2.8% -1 34% 3.5 -0.5% 1 17% 0.0%SXRP (Retail) 22.1% -0.1% 90% 23.4% 1.7% 0 89% 5.9 3.5% -1 94% 2.8 -0.6% 1 7% 0.5%SXTP (Trvl&Lsre) 19.9% -0.1% 55% 26.9% 1.7% -1 65% 6.0 3.2% -1 53% 3.1 -0.2% -1 69% 0.4%Source: BofA Merrill Lynch Global Research *Real vol = EWMA (Exponentially Weighted Moving Average) volatility, which measures historical price volatility but assigns greater importance to recent returns. Sigma(t)^2 =0.94*Sigma(t-1)^2+(1-0.94)*r(t)^2, where r(t) is the return on day t. **Indicative mid prices; strikes as % of forward ***Negative values indicate that the bullish risk reversal takes in a credit.EquityindexWeeklyreturn14 Global Equity Volatility Insights | 09 August 2016Volatility in AsiaOwn NKY calendar call going into the uncertainty Sep BOJTrade update: Closing the NKY Aug/Sep put calendar trade opened on 25-JulThe short NKY Aug16 15500 put vs. long NKY Sep16 15500-14500 put spread tradewas opened on 25-Jul at 0.24% premium and was closed at 0.28% premium on 8-Aug aswe are approaching the Aug16 expiry. In addition, the Sep-16 NKY put spread hasalready carried well by selling the inflated BOJ risk premium even with the spot beinglargely unchanged.NKY & USDJPY 1Mth vols are down to YTD low: Pricing in a slow summerWith the Japanese government announcing a ¥28.1tn fiscal stimulus package last week,the Abe administration has laid out both its new monetary and fiscal policies. In theshort-term, there are few catalysts and both NKY and USDJPY 1Mth implied volatilitieshave retraced materially. VNKY is at 21.5 and USDJPY 1M ATM vol is at 9.8%, near theirYTD low levels.USDJPY 2M-1M term structure at its steepest & NKY’s in its 98 th %-ile since ‘11FX has been the main driver in the current Macro world. Chart 29 shows that theUSDJPY 2-month minus 1-month term structure is at its highs since 2011. The Sep BOJmeeting is expected to be held on 21-Sep so USDJPY 1-month options do not cover theevent. Notably, the NKY term structure is also very steep at 1.5%, which is in its 98 thpercentile since 2011. The NKY term structure was at its steep at 2.5% in Dec-13.Chart 28: Japanese equity volatility has dropped to YTD lows; USDJPYshort-dated vol also retraced to near YTD low levelsChart 29: USDJPY 2M-1M ATM term structure (1.7%) is at its 5-year highwhile the NKY 2M-1M term structure (1.5%) is at its 98 th percentile55%50%45%40%35%30%25%20%Jan-16Feb-16Mar-16Apr-16May-16Jun-16Jul-16Aug-1621.5%17%16%15%14%13%12%11%10%9%8%2%1%0%-1%-2%-3%Jan-11May-11Sep-11Jan-12May-12Sep-12Jan-13May-13Sep-13Jan-14May-14Sep-14Jan-15May-15Sep-15Jan-16May-16VNKYUSDJPY 1M ATM vol (RHS)USDJPY 2Mth Minus 1Mth ATM Vol Current Level (1.7%)Source: BofA Merrill Lynch Global Research. Daily data from 5-Jan-16 to 5-Aug-16Source: BofA Merrill Lynch Global Research.BofAML: BoJ plans for Sep16 'comprehensive assessment' create uncertaintyThe BOJ’s decision in keeping “QE” or interest rate unchanged in July highlighted theBOJ’s limits in expanding JGB purchases and digging deeper into negative interest rateterritory. More importantly, the central bank announced it will conduct a comprehensiveassessment of its policy at its Sep meeting. By giving guidance for the next meeting,the BoJ has inevitably focused market attention on possible changes to the monetarypolicy framework. Significant monetary easing, including helicopter money, cannot beruled out, but the more likely scenario is that the BoJ makes current monetary policy,which is fixed on achieving 2% inflation target in a short period of time, more 'flexible'.Market expectation for the Sep BOJ in terms of fwd vol is the near its lows YTDWith NKY Sep ATM vol at 17.8% and Oct ATM at 20%, the NKY Sep-Oct ATM forwardvol is at 21.8%, which is at the low end of the trading range going into BOJ events thisyear (Chart 30). We think there is value in owning forward vol via calendar options.Global Equity Volatility Insights | 09 August 2016 15A further squeeze in US and Japanese yields is most positive Japan in AsiaThe strong US NFP print and the large Japan fiscal plan catalysed a global selloff inbonds. Chart 31 shows that NKY is the most sensitive Asian market to rising USD & JPYyield since 2010 with a correlation of 31%.Buy 1x NKY Oct 17500 call, short 0.65x Sep 17250 call: Gamma neutral, long volGiven the low market expectation in the BOJ and a potential rally in Japanese equities onthe back of further yield squeeze and rising BOJ expectation next month, we like owning1x NKY Oct 17500 call vs. selling 0.65x of Sep 17250 call for 0.7% (¥116). The trade willhave a positive 9% delta, 8bps of vega and flat gamma & theta initially.Indicative pricing (As of 8-Aug-16, Ref: 16650)Buy 1x NKY Oct 17500 call: 1.13% (¥187) (iv: 19.2, delta: 24%, gamma: 3.8%)Sell 0.65x NKY Sep 17250 call: 0.66% (¥110) (iv: 16.9, delta: 23%, gamma: 5.9%)Net: 0.70% (¥116) (delta: +9, vega: 0.08%)Chart 30: Current NKY Sep-Oct ATM volatility is cheap relatively toimplied volatility going into previous BOJ meetings in 2016Front Month ATM Vol before BOJ45%40%35%30%25%Jan16 BOJApr16 BOJJul16BOJMar16 BOJJun16 BOJCurrent SepOct Vol20%-16 -15 -14 -13 -12 -11 -10 -9 -8 -7 -6 -5 -4 -3 -2 -1 -Number of Trading Days before BOJSource: BofA Merrill Lynch Global ResearchChart 31: The Nikkei is the most sensitive to rising USD and JPY ratesamong Asian indices40%Correlation of Index vs. 10Yr USD & JPY Rates 31.1%30%20.5%20%16.5% 17.0% 17.2%10%0%-1.7%-10% -6.5%NIFTY KOSPI2 HSCEI TWSE HSI AS51 NKYCorrelation of Index vs. 10Yr USD & JPY RatesSource: BofA Merrill Lynch Global Research. Weekly correlation since 2010Chart 32: Mark-to-Market of the long 1x NKY Oct 17500 call, short NKY Sep 17250 call structureMark-to-Market in Yen400300200100-1500015100152001530015400155001560015700158001590016000161001620016300164001650016600167001680016900170001710017200173001740017500176001770017800179001800018100182001830018400185001860018700188001890019000Buy NKY Oct 17500C, Short 0.65x Sep 17250C (At Inception)Source: BofA Merrill Lynch Global Research Assume volatility stays constantBuy NKY Oct 17500C, Short 0.65x Sep 17250C (1day Before Sep expiry)16 Global Equity Volatility Insights | 09 August 2016Week in review & notable trends (Asia)The MSCI Asia-Pac USD Index inched down 48bps in an eventful week in terms of macronews, with equities gains offset by USD strength. Following the monetary policychanges announced during the BoJ, the Abe Cabinet approved a fiscal stimulus packagetotalling ¥28.1tn last week. However, the Nikkei fell 190bps and the yen advancedanother 32bps over the week. The Korean government submitted a KRW28tn fiscalpackage proposal to the Congress, which our economists believe should sustain growthnear term; the KOSPI2 was little changed (adding 35bps). The RBA cut rates by 25bpsas our economists expected, but Australian stocks declined with the ASX 200 dropping117bps. Elsewhere in Asia, the HSI, HSCEI, TWSE and Nifty rallied 1.2%, 1.9% 1.2% and0.5%, respectively.Japanese equity implied volatility dropped to YTD lows• Last week, most major Asian implied vols edged down as underlying indices rallied;ASX 200 vol increased slightly despite the rate cut• NKY vol saw a larger decline, with 3M ATM vol dropping 1.1 vol pts to 21.7% mainlydue to diminished uncertainty as the fiscal package rolled out• Most Asian skews flattened and term structures steepened, especially the Nikkeiterm structure (spread between 1yr and 1M ATM vols), which increased 3.0 vol ptsand turned positiveNKY Uridashi issuance continues to fall as existing ones haven’t knocked-outDespite the falling NKY and relatively high implied volatility, Japanese Uridashi issuancehas further retraced as most existing products have not knocked-out. In Jul-16, therewas $450mn Uridashi products issued which are NKY linked. We estimate that the peakof vega profile is around the current spot.Chart 33: In Jul-16, there was $450mn Uridashi products issued whichare NKY linked1.61.4New NKY Linked Uridashi issuance22,00021,0001.2NKY Index20,0001.019,0000.818,0000.617,0000.416,0000.215,000-14,000Issuance (US$bn)Aug-14Dec-14Apr-15Aug-15Dec-15Apr-16Aug-16NKY lndexChart 34: At current NKY levels, the estimated total vega of the NKYlinkedUridashi products is ~US62mn, near the peak of the vega profileEstimate outstanding vega (US$mn)70605040302010013,00014,000Uridashi NKY outstanding vega15,00016,000Outstanding vega for Uridashiproductsis ~US$62mn17,00018,00019,00020,00021,00022,000Source: BofA Merrill Lynch Global Research.Source: BofA Merrill Lynch Global Research.NKYGlobal Equity Volatility Insights | 09 August 2016 17Chart 35: issuance of Korean structured products ticked up in Jul-16, butstays relatively low as majority of the products still haven’t knocked out3,500KOSPI2HSCEI90003,000SX5ESPX80002,500HSITotal issuance (RHS) 700060002,00050001,50040001,000300020005001000-0USD MnJul15Aug15Sep15Oct15Nov15Dec15Jan16Feb16Mar16Apr16May16Jun16Jul16Source: BofA Merrill Lynch Global Research.USD MnKorean structured product issuance increased to US$1.9bnin July; KOSPI2-linked products dominatedKorean auto-callable product issuance ticked up last month,with a total of US$ 1.9bn notional issued, vs. US$ 1.6bn totalissuance in June.Looking at individual underlyings, KOSPI2-linked products(currently US$578mn) saw the largest increase. KOSPI2-linkedissuance hence took over SX5E-linked issuance (currentlyUS$436mn), which was relatively unchanged compared to June.HSCEI-linked issuance (currently US$ 69mn) further declinedwhereas HSI-linked issuance (currently US$ 262mn) increasedagain. SPX-linked issuance grew to US$ 281mn.KOSPI2 outstanding vega: US$23mnHSCEI outstanding vega: US$74mnChart 36: We estimate that structured product Issuers are currently longUS$23mn of KOSPI2 vega80KOSPI2 Autocall Vega Outstanding ProfileEstimate KOSPI2 outstanding vega(US$mn)70605040302010-170180190200210220230240250260270280290300310Source: BofA Merrill Lynch Global Research.KOSPI2 Spot LevelChart 37: We estimate that structured product Issuers are currently longUS$74mn of HSCEI vega100HSCEI Autocall Vega Outstanding Profile908070605040302010-Estimate HSCEI outstanding vega(US$mn)650070007500800085009000950010000105001100011500120001250013000Source: BofA Merrill Lynch Global Research.HSCEI Spot LevelTable 5: Volatility measures of major Asian indices (data as of 5-Aug-16)3Mth ATM Implied Volatility 10D Realized Volatility 12Mth-1Mth ATM Vol Spread 3Mth 90-110 Skew Spread Equity MarketWeekly 4Yr Weekly 4Yr Weekly 4Yr Weekly 4Yr WeeklyCurrent change percentile Current change percentile Current change percentile Current change percentile returnHSI 17.5% -0.6% 57.2% 15.7% 4.9% 56.4% 2.2% 0.3% 52.0% 5.4% -0.2% 82.8% 1.2%HSCEI 20.8% -0.5% 30.4% 17.4% 6.6% 38.1% 3.3% 0.2% 88.9% 4.2% -0.7% 77.5% 1.9%NKY 21.7% -1.1% 47.3% 19.2% 2.0% 46.2% 1.2% 3.0% 67.5% 5.1% -0.3% 75.9% -1.9%KOSPI2 12.6% -0.4% 15.4% 12.4% 7.1% 57.5% 3.9% 0.5% 75.6% 5.2% -0.7% 80.5% 0.3%ASX 200 14.3% 0.5% 60.1% 9.9% 4.7% 34.0% 2.7% 0.1% 64.2% 7.1% 0.0% 55.6% -1.2%NIFTY 14.2% -0.2% 6.3% 11.8% 2.9% 32.6% 2.6% 0.7% 38.4% 5.8% 0.6% 74.0% 0.5%TWSE 14.6% -0.3% 63.1% 10.2% 2.0% 37.2% 0.7% 1.0% 16.8% 4.1% -0.5% 63.5% 1.2%Source: BofA Merrill Lynch Global Research18 Global Equity Volatility Insights | 09 August 2016TWSE 3M 25d-Call IV over SPX is near its 4-year highsTable 6 lists Asian index pairs with the highest IV ratio vs. their 4-year histories. Forinstance, the ratio of TWSE 3M 25d-Call vol over SPX is near its 4-year highs.Chart 38: The ratio of TWSE 3M 25d-Call IV over SPX is near its 4-yrhighs (Daily data from 1-Jan-11 through 5-Aug-16)Implied VolTWSE 3M 25d-Call vol SPX 3M 25d-Call vol Vol ratio40%1.635%1.530%1.425%1.31.220%1.115%1.010%0.95%0.8Jan-11May-11Sep-11Jan-12May-12Sep-12Jan-13May-13Sep-13Jan-14May-14Sep-14Jan-15May-15Sep-15Jan-16May-16RatioTable 6: Index pairs^ with the highest implied vol ratio vs. their histories(data as of 5-Aug-16)Index A(Implied vol)Index B(Implied Vol)A/B ImpliedVol ratioRatio 4-yrpercentile3M ATM TWSE (14.6%) SPX (11.8%) 1.23 97%6M ATM SX5E (20.0%) SPX (13.7%) 1.46 96%12M ATM SX5E (20.2%) SPX (15.4%) 1.31 98%3M 25d-Put TWSE (17.1%) SPX (15.5%) 1.10 97%6M 25d-Put TWSE (17.8%) SPX (17.9%) 0.99 93%12M 25d-Put SX5E (24.2%) SPX (19.9%) 1.22 96%3M 25d-Call TWSE (13.9%) SPX (9.9%) 1.41 97%6M 25d-Call SX5E (17.5%) SPX (11.3%) 1.54 97%12M 25d-Call SX5E (18.2%) SPX (12.8%) 1.42 98%Source: BofA Merrill Lynch Global Research^ Index universe includes the ASX200, HSCEI, HSI, KOSPI2, NIFTY, NKY, TWSE, SPX and SX5E* mid level implied volSource: BofA Merrill Lynch Global Research. Daily data from 1-Jan-11 through 5-Aug-16Global Equity Volatility Insights | 09 August 2016 19Summary of Open Trades (08-Aug-16)Table 7: Summary of open trades as of 08-Aug-16Trade DescriptionOpenDateOpenLevelTradeValueExpectedTrade Term RationaleLong SX5E vs short SPX Dec18 var swap 5-Jul-16 6.1 vols 5.2 volsInvestors should re-assess attractiveness of popular and (typically) technicallyLong NKY vs short SPX Dec18 var swap 5-Jul-16 5.7 vols 4.9 vols Dec-18 expiry motivated longer-dated RV vol trades, given environment of structurally higherLong SX5E vs short SPX Dec18 put vs put 5-Jul-16 0.00% -0.62%political & economic risks and increasingly limited policy optionsLong 3M 25d EFA put vs short 3M 25d UKX put 5-Jul-16 0.00% 0.16% 3 months FTSE 3M 25d put vol near 7hr highs vs. vol on EFABuy CMB Sep16 105-115% call spreadBuy ICBC Sep16 105-115% call spreadBuy BOC Sep16 105-115% call spread5-Jul-165-Jul-165-Jul-162.32%2.12%2.10%3.01%4.17%3.79%Sep-16 SQexpiryContinuous Southbound inflow benefit financials sector and narrow AH premiumLong 0.5x V2X Oct16 future, long 0.5x V2X Nov16future, short V2X Jan-17 future11-Jul-16 0.25 vols -0.28 vols Oct-16 expiry Hedge further Brexit fallout, Italian bank & referendum riskBuy a 6M ATM worst-of call on XLP & GLD 11-Jul-16 1.05% 0.48% 6 months Cheaply construct risk-limited “uber-barbell” portfolioBuy a 6M ATM worst-of {SPX put, GLD call} 11-Jul-16 1.60% 1.01% 6 months Low-cost macro hedge for US equity portfoliosBuy Oct16 110%f calls on VIE FP, AI FP, IBE SQ,STAN LN and MUV2 GYBuy an Oct16 110%F call on an equally weightedbasket (quanto EUR)18-Jul-1618-Jul-162.37%0.81%2.37%0.69%Buy TLS 25-Aug16 95% puts 18-Jul-16 1.05% 1.67%Buy CSL 25-Aug-16 95% puts 18-Jul-16 1.09% 0.72%Buy Newcrest 25-Aug-16 105/115% call spreads 18-Jul-16 2.64% 1.90%Buy BHP 25-Aug-16 105/115% call spreads 18-Jul-16 2.22% 1.26%Replace T long position via 3M ATM calls 19-Jul-16 2.72% 2.50%Replace LOW long position via 3M ATM calls 19-Jul-16 3.90% 3.66%Replace RTN long position via 3M ATM calls 19-Jul-16 3.16% 3.45%Replace CRM long position via 3M ATM calls 19-Jul-16 4.16% 3.50%Replace CRM long position via 3M ATM calls 19-Jul-16 2.32% 1.26%Oct-16 expiryOct-16 expiry25-Aug-163 monthsAdd exposure via inexpensive upside on single names where positioning appearsparticularly bearish and stocks have underperformed vs. their sectorsTo hedge potential earning downside surpriseTo hedge potential earnings upside surprisesOur analysts expect positive and impactful catalysts in Q3-2016; recent strongperformance and depressed short dated implied vol favor stock replacement viacalls to reduce downside risk, maintain upside and lock in profitsOverlay long WBA long position with 3M ATM calls 19-Jul-16 4.04% 2.49% 3 months Position for accelerated upside returns ahead of closing the Rite Aid acquisitionBuy a 6M ATM best-of put on SPX & TLT 18-Jul-16 0.8% 0.49% 6 months Cheap hedge against a bond tantrumBuy a 1Y ATM worst-of call on SPX & TLT 18-Jul-16 0.9% 0.83% 1 year Cheap equity upside in a bond / equity melt-upBuy XLF Sep 24 strike call 25-Jul-16 1.4% 1.9%Sep-16 expiryBuy XLU Sep 51 strike put 25-Jul-16 1.3% 2.5%Buy a 6M ATM worst-of {XLF call, XLU put} 25-Jul-16 1.35% 2.31% 6 monthsSell 1x SX7E 1M 25d call to fully finance 1.85xSX5E 1M 25d callsShort VIX Oct 15 put vs. long VIX Nov 19/26 callspread1-Aug-16 $0.45 $0.125 Oct VIX expiryRecord outperformance of Utilities vs. Financials + FMS positioning + central bankcatalysts = potential for cyclicals / defensives mean reversion25-Jul-16 0.0% 0.28% 1 month SX7E 1M 25d call / SX5E 1M 25d call price ratio is in the 100 th 2-yr percentileSell VIX Oct puts to leverage likely floor in vol ahead of US elections and cheapenshallow hedgesBuy HSCEI Aug16 9400 call, Short Oct16 10000 call 1-Aug-16 0.00% 0.04% Aug-16 expiry Short-term bullish China trade with term structure at its steepest in 4yrsSource: BofA Merrill Lynch Global Research. Prices reflective of most recently available data which may be delayed in some cases. “Trade Value” represents current valuation of trades initiated on the “Open Date”.Summary of Closed Trades (08-Aug-16)Table 8: Summary of closed trades as of 08-Aug-16OpenDateOpenLevelCloseLevel Close Date RationaleTrade DescriptionBuy NKY Aug-16 105%-110% call spreads & sell90% puts11-Jul-16 0.26% 1.73% 25-Jul-16 Take profit as the hurdle to surprise on the upside is high following a 5.8% NKY rallyReplace FB long positions via Oct-16 ATM calls 25-Jul-16 5.9% 6.1% 1-Aug-16 Take profit as Facebook rallied on better-than expected Q2 resultsReplace AMZN long positions via Oct-16 ATM calls 25-Jul-16 5.5% 6.3% 1-Aug-16 Take profit as Amazon rallied on better-than expected Q2 resultsBuy AAPL Oct-16 ATM protective puts 25-Jul-16 4.6% 1.2% 1-Aug-16 Remove protection as worries around disappointing Q4 guidance faded post earningsBuy 1.5x 5-Aug-16 2950-3000 strangles by selling1x 19-Aug-16 2950-3000 stranglesSell NKY Aug16 15500 puts, Buy Sep16 15500-14500 put spreads25-Jul-16 0.00% -1.12% 5-Aug-16 The BoJ, Fed & EU bank stress tests could move mkts sharply in the near term25-Jul-16 0.24% 0.28%Aug-16 expiry &Sep-16 expiryUnwinding before the Aug16 expiry; The NKY Sep put spread has carried wellSource: BofA Merrill Lynch Global Research. Prices reflective of most recently available data which may be delayed in some cases. “Trade Value” represents current valuation of trades initiated on the “Open Date”.20 Global Equity Volatility Insights | 09 August 2016Volatility in Numbers (05-Aug-16)Table 9: Statistics on implied, realised, skew and term structure for 3-month and 12-month vols (developed markets)3-month12-monthS&P500 ESTX50 FTSE DAX NKY HSI KOSPI S&P500 ESTX50 FTSE DAX NKY HSI KOSPIImplied 11.9% 19.2% 12.6% 17.8% 21.7% 17.5% 12.6% 15.4% 20.2% 15.9% 19.6% 21.1% 18.6% 15.0%%tile (2yr) 4.4% 30.2% 20.2% 19.0% 51.5% 30.4% 18.1% 13.1% 46.0% 46.2% 33.7% 53.2% 34.3% 24.4%1Week Change -0.7% -0.6% -0.7% -1.1% -1.1% -0.6% -0.4% -0.6% -0.4% -0.2% -0.7% -0.7% -0.2% -0.2%1Mth Change -2.5% -5.2% -5.1% -5.8% -1.9% -1.8% -0.5% -1.6% -2.6% -1.9% -2.8% -1.0% -0.5% -0.2%Realised 13.1% 27.5% 18.9% 24.4% 27.0% 17.3% 12.8% 17.0% 26.1% 20.5% 25.6% 29.4% 21.9% 14.3%%tile (2yr) 45.0% 79.9% 69.6% 68.9% 69.1% 42.2% 65.9% 95.6% 94.3% 96.4% 95.8% 98.4% 73.8% 96.7%1Week Change -0.1% 0.4% 0.2% -0.1% -1.2% -0.3% 0.6% 0.0% -0.2% 0.1% 0.0% 0.1% -0.1% 0.1%1Mth Change -0.4% -0.5% -0.4% -0.5% -2.7% -1.1% 0.8% -0.2% -0.1% -0.1% -0.2% 0.2% -1.6% -0.1%Imp-real spread -1.2% -8.3% -6.4% -6.6% -5.3% 0.2% -0.3% -1.6% -5.9% -4.6% -6.0% -8.3% -3.3% 0.8%Spread %tile (2yr) 19.8% 3.1% 8.3% 4.8% 22.5% 37.9% 18.1% 0.2% 0.0% 0.0% 0.0% 0.0% 9.5% 0.8%1Week Change -0.6% -0.9% -0.9% -1.0% 0.2% -0.3% -1.0% -0.6% -0.2% -0.3% -0.7% -0.8% -0.1% -0.3%1Mth Change -2.1% -4.6% -4.7% -5.3% 0.8% -0.7% -1.3% -1.4% -2.5% -1.8% -2.6% -1.2% 1.1% -0.1%90-110 skew 9.5% 8.4% 7.5% 8.6% 5.1% 5.4% 5.2%%tile (2yr) 3.3% 78.5% 9.4% 77.6% 53.4% 69.2% 64.2%1Week Change -0.2% -0.1% 0.0% -0.4% -0.2% -0.2% -0.7%1Mth Change -2.6% -0.4% -3.2% -0.5% -1.2% -1.3% -0.6%10-day realised12M - 3M term vol spreadS&P500 ESTX50 FTSE DAX NKY HSI KOSPI S&P500 ESTX50 FTSE DAX NKY HSI KOSPICurrent Level 6.0% 15.7% 10.5% 13.3% 18.6% 14.9% 11.9% 3.5% 1.0% 3.4% 1.8% -0.5% 1.1% 2.4%%tile (2yr) 7.1% 22.0% 24.1% 9.3% 45.6% 36.7% 52.8% 98.3% 86.6% 100.0% 96.0% 50.8% 69.2% 72.2%1Week Change 1.6% 5.2% 4.9% 2.4% 2.1% 4.5% 6.8% 0.1% 0.2% 0.5% 0.4% 0.4% 0.5% 0.3%1Mth Change -20.0% -37.1% -23.2% -30.1% -26.1% -6.7% -5.3% 0.9% 2.5% 3.2% 2.9% 0.9% 1.3% 0.3%Cash indexCurrent Level 2,182.87 2,973.71 6,793.47 10,367.21 16,254.45 22,146.09 252.361Wk Change 0.43% -0.57% 1.03% 0.29% -1.90% 1.16% 0.35%1Mth Change 4.52% 5.72% 3.79% 8.76% 3.73% 6.72% 2.21%Source: BofA Merrill Lynch Global ResearchTable 10: Statistics on implied, realised, skew and term structure for 3-month and 12-month vols (emerging markets)3-month12-monthEEM US IBOV RDXUSD TOP40 EEM US IBOV RDXUSD TOP40Implied 18.8% 21.7% 28.2% 19.4% 21.2% 23.5% 29.3% 21.8%%tile (2yr) 34.5% 2.4% 5.5% 59.1% 40.7% 22.0% 16.4% 80.2%1Wk Change -0.8% 0.0% -1.6% 0.3% -0.9% -0.1% -1.3% 0.4%1Mth Change -3.6% -3.0% -3.8% -2.3% -2.2% -1.9% -3.3% -1.0%Realised 22.1% 21.8% 25.7% 17.9% 24.3% 27.7% 36.2% 20.4%%tile (2yr) 65.9% 27.2% 20.8% 47.5% 94.8% 94.0% 45.7% 94.0%1Wk Change -0.8% -0.5% -0.6% -0.4% -0.1% 0.0% -0.2% -0.1%1Mth Change -1.5% -4.4% -4.2% -0.3% -0.6% -0.2% -0.4% -0.6%Imp-real spread -3.2% -0.1% 2.6% 1.5% -3.1% -4.3% -6.9% 1.4%Spread %tile (2yr) 12.9% 44.2% 52.4% 51.1% 0.2% 0.0% 0.0% 16.6%1Wk Change -0.1% 0.5% -1.0% 0.7% -0.9% 0.0% -1.1% 0.6%1Mth Change -2.1% 1.4% 0.4% -2.0% -1.6% -1.7% -2.9% -0.4%90-110 skew 7.8% 5.3% 6.0% 8.7%%tile (2yr) 63.8% 48.5% 14.8% 62.6%1Wk Change 0.3% 0.0% -0.1% -0.2%1Mth Change 0.0% -0.5% -0.8% -0.6%Global Equity Volatility Insights | 09 August 2016 21Table 10: Statistics on implied, realised, skew and term structure for 3-month and 12-month vols (emerging markets)10-day realised12M - 3M term vol spreadEEM US IBOV RDXUSD TOP40 EEM US IBOV RDXUSD TOP40Current Level 10.4% 13.2% 18.5% 11.0% 2.4% 1.8% 1.1% 2.3%%tile (2yr) 4.2% 3.4% 5.3% 16.6% 74.1% 98.3% 88.1% 90.0%1Wk Change -0.5% 2.4% 6.2% 2.3% -0.1% -0.1% 0.3% 0.1%1Mth Change -31.3% -15.2% -8.8% -19.6% 1.5% 1.1% 0.5% 1.3%Cash indexCurrent Level 36.62 57,661.14 1,090.44 45,385.741Wk Change 1.15% 0.62% 1.72% -1.16%1Mth Change 7.86% 11.22% 1.44% 0.12%Source: BofA Merrill Lynch Global Research22 Global Equity Volatility Insights | 09 August 2016Analyst CertificationI, Benjamin Bowler, hereby certify that the views expressed in this research reportaccurately reflect my personal views about the subject securities and issuers. I alsocertify that no part of my compensation was, is, or will be, directly or indirectly, relatedto the specific recommendations or view expressed in this research report.Global Equity Volatility Insights | 09 August 2016 23Options Risk StatementPotential Risk at Expiry & Options Limited Duration RiskUnlike owning or shorting a stock, employing any listed options strategy is by definitiongoverned by a finite duration. The most severe risks associated with general optionstrading are total loss of capital invested and delivery/assignment risk, all of which canoccur in a short period.Investor suitabilityThe use of standardized options and other related derivatives instruments areconsidered unsuitable for many investors. Investors considering such strategies areencouraged to become familiar with the "Characteristics and Risks of StandardizedOptions" (an OCC authored white paper on options risks). U.S. investors should consultwith a FINRA Registered Options Principal. For detailed information regarding the risksinvolved with investing in listed options:http://www.theocc.com/about/publications/character-risks.jsp24 Global Equity Volatility Insights | 09 August 2016DisclosuresImportant DisclosuresFUNDAMENTAL EQUITY OPINION KEY: Opinions include a Volatility Risk Rating, an Investment Rating and an Income Rating. VOLATILITY RISK RATINGS, indicators of potentialprice fluctuation, are: A - Low, B - Medium and C - High. INVESTMENT RATINGS reflect the analyst’s assessment of a stock’s: (i) absolute total return potential and (ii)attractiveness for investment relative to other stocks within its Coverage Cluster (defined below). There are three investment ratings: 1 - Buy stocks are expected to have a totalreturn of at least 10% and are the most attractive stocks in the coverage cluster; 2 - Neutral stocks are expected to remain flat or increase in value and are less attractive thanBuy rated stocks and 3 - Underperform stocks are the least attractive stocks in a coverage cluster. Analysts assign investment ratings considering, among other things, the 0-12month total return expectation for a stock and the firm’s guidelines for ratings dispersions (shown in the table below). The current price objective for a stock should bereferenced to better understand the total return expectation at any given time. The price objective reflects the analyst’s view of the potential price appreciation (depreciation).Investment rating Total return expectation (within 12-month period of date of initial rating) Ratings dispersion guidelines for coverage cluster*Buy ≥ 10% ≤ 70%Neutral ≥ 0% ≤ 30%Underperform N/A ≥ 20%* Ratings dispersions may vary from time to time where BofA Merrill Lynch Research believes it better reflects the investment prospects of stocks in a Coverage Cluster.INCOME RATINGS, indicators of potential cash dividends, are: 7 - same/higher (dividend considered to be secure), 8 - same/lower (dividend not considered to be secure) and 9 - paysno cash dividend. Coverage Cluster is comprised of stocks covered by a single analyst or two or more analysts sharing a common industry, sector, region or other classification(s). 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