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Global Equity Volatility Insights
Why S&P vol dispersion may be the best
way to trade a bubble in Tech
we estimate 68% of the
06 June 2017
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US
How to detect and position for a potential Tech Bubble
Our investment strategists recently warned against the risk of an overshoot in US Tech,
as data on valuations, relative performance, and inflows invoke echoes of the late ‘90s.
However, rising Tech vol alongside rising Tech stock prices – a classic sign of an asset
bubble – has yet to materialize, suggesting still early stages of bubble formation.
Derivatives can be a key tool for trading bubbles, allowing investors to capture asset
price upside while mitigating reversal risk. To this end, we like stock replacing FANG
positions or overlaying Tech exposure with Nasdaq 100 (NDX) put spreads. Long
volatility dispersion strategies are particularly well-suited for trading asset bubbles, in
our view, as they can profit from both the inflation and deflation of a bubble without
needing to time the top. Specifically, we like SPX 12M Top50 dispersion to position for
a potential Tech Bubble as (i) the Top50 basket is dominated by Tech stocks, hence
would benefit from any rise in their vol from currently low levels; (ii) the trade would
benefit from any downward pressure on broad-market correlations as Tech stocks
decouple from other large caps; and (iii) the late ‘90s Tech Bubble generated the most
sustained period of elevated S&P vol dispersion in history.
Europe
DTE Sep17 collars can hedge DTE-TMUS merger risk; value in Enel bullish riskies
DTE GY has run too fast, too quick: investors who own stock should consider hedging a
pullback using a Sep17 collar (+17put/-18 call for 46bps) to hedge losses greater than
2.9% while retaining upside to 18 (stock’s ~15yr high is 18.05). Extending our EU equity
vs credit theme to single names, we find Enel 3m bullish risk reversals screen attractive
as Enel’s projected 12m div yield is high versus Enel CDS (suggesting value in owning
equity vs credit) and the price of 3M bullish risk reversals is low (versus other names) as
well as versus history (2 nd 5y percentile).
Asia
Buy best-of puts to cheaply hedge a reversal in the melt-up rally
While still high central bank liquidity may continue to push markets higher, heavy equity
and option positioning suggests the risk of a market reversal. To minimize the cost of
hedges and take advantage of the recent decline in volatility and correlation, we suggest
owning 14-Sep-2017 95% strike best-of puts on KOSPI2/HSI/NKY at 0.8%, a 45%
discount to average vanilla puts.
>> 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 32 to 36. Analyst Certification on page 29. Price Objective
Basis/Risk on page 29. 11753360
Timestamp: 06 June 2017 01:43AM EDT
Equity Derivatives
Global
Global Equity Derivatives Rsch
MLPF&S
Nitin Saksena
Equity-Linked Analyst
MLPF&S
Stefano Pascale
Equity-Linked Analyst
MLPF&S
Benjamin Bowler
Equity-Linked Analyst
MLPF&S
benjamin.bowler@baml.com
William Chan, CFA >>
Equity-Linked Analyst
Merrill Lynch (Hong Kong)
Michael Youngworth
Equity-Linked Analyst
MLPF&S
Clovis Couasnon >>
Equity-Linked Analyst
MLI (UK)
Jason Galazidis >>
Equity-Linked Analyst
MLI (UK)
Abhinandan Deb >>
Equity-Linked Analyst
MLI (UK)
Nikolay Angeloff
Equity-Linked Analyst
MLPF&S
See Team Page for List of Analysts
Table 1: 3M volatility (weekly changes)
Implied Realized
S&P500 9.5 (-0.1) 7.3 (-0.4)
ESTX50 13.0 (-0.4) 11.1 (-0.6)
FTSE 10.6 (0.4) 9.2 (-0.5)
DAX 12.2 (-0.7) 9.9 (-0.7)
NKY 14.2 (-0.2) 12.5 (0.1)
HSI 12.4 (0.3) 10.1 (-0.2)
KOSPI 12.8 (-0.3) 10.6 (0.0)
EEM US 15.4 (-0.1) 13.2 (-0.8)
TOP40 15.1 (1.0) 10.9 (0.0)
RDX 24.7 (1.2) 21.9 (0.0)
IBOV 25.3 (0.5) 26.4 (-0.2)
ISE30 19.6 (-0.2) 14.0 (-0.4)
Source: BofA Merrill Lynch Global Research
BofAML GFSI TM X-Asset Risk Landscape
GFSI below ‘normal’ for longest period since summer 2014
The GFSI continued its decline last week, falling to -0.21 as of 2-Jun from -0.17 a week
prior. The indicator last spent a significant proportion of time below -0.2 back in
summer 2014, when cross asset volatility recorded long term lows.
• Equity risks led the broad based decline in stress across asset classes
(Chart 2 and Chart 3), led by equity skew.
• While most stresses fell, crude oil volatility was among the top gainers
(Chart 2) as oil continued its slide despite the May OPEC meeting seeing
agreement for extending production cuts.
• Also, Euro member bond spreads recorded a historically significant move
higher (Chart 5) as the potential for early Italian elections causing political
instability amidst ECB tapering revived concerns about European sovereign risk
Chart 1: Latest* stress across GFSI sub-components
2.0
1.5
Red shaded area highlights components in
1.0
0.5
0.0
-0.5
-1.0
-1.5
GFSI Stress
1.61
1.49
Basis Swap USDJPY
Govt-OIS EUR
1.08
0.99
Basis Swap EURUSD
Euro member Bond…
0.81
Bond Basis EUR
USDJPY Skew
Nikkei Skew
Govt-OIS USD
CDS Index Skew USD
HY Bond Flow
CDS Index Skew EUR
Source: BofA Merrill Lynch Global Research. *Latest as of 2-Jun-17.
Bond Basis USD
IG Foreign Sovrn Bond…
Libor-OIS USD
GBPUSD Imp Vol
Volume Flow
Libor-OIS GBP
Libor-OIS JPY
Risk
Skew
Flow
Green shaded area highlights components in
Bullish territory
-1.06
-1.08
-1.19
-1.20
-1.29
EURJPY Skew
AUDJPY Skew
Equity Fund Flow EM
Sub IG Foreign Sovrn…
Libor-OIS EUR
HY Corp CDS USD
Comdty Imp Vol Crude
IG Corp CDS EUR
ESTX50 Skew
IG Corp CDS USD
HY Corp CDS EUR
SP500 Skew
USDJPY Imp Vol
HSI Imp Vol
FTSE Imp Vol
Money Mkt Flow
3Y/5Y Credit Curve EUR
Comdty Imp Vol Gold
ESTX50 Imp Vol
Comdty Imp Vol Copper
SP500 Imp Vol
Int Rate Imp Vol USD
Nikkei Imp Vol
EURUSD Imp Vol
Int Rate Imp Vol EUR
Chart 2: Change** in stress across GFSI sub-components.
0.4
Change in GFSI Stress
0.0
-0.4
-0.8
0.23
0.19
CDS Index Skew USD
Bond Basis EUR
0.16
0.10
Comdty Imp Vol Crude
Euro member Bond…
0.09
IG Foreign Sovrn Bond…
GBPUSD Imp Vol
Govt-OIS EUR
FTSE Imp Vol
Comdty Imp Vol Gold
Source: BofA Merrill Lynch Global Research. **Latest as of 2-Jun-17. Change vs 1 week prior (26-May-17).
Equity Fund Flow EM
HSI Imp Vol
Libor-OIS JPY
USDJPY Imp Vol
The GFSI Risk Allocator (using Bull, Bear & Neutral weights of 2, 0, 1) suggested a 21.7%
overweight position on 2-Jun (vs 13.0% OW as of 26-May). The percentages of Bullish,
Bearish and Neutral GFSI components (as used in the Risk Allocator) as of 2-Jun were
30.4%, 8.7% and 60.9% respectively.
3Y/5Y Credit Curve EUR
EURJPY Skew
IG Corp CDS EUR
Sub IG Foreign Sovrn…
Volume Flow
USDJPY Skew
Bond Basis USD
Int Rate Imp Vol USD
HY Corp CDS EUR
SP500 Imp Vol
HY Corp CDS USD
AUDJPY Skew
Basis Swap EURUSD
Money Mkt Flow
Libor-OIS GBP
Nikkei Imp Vol
Risk
Skew
Flow
HY Bond Flow
EURUSD Imp Vol
Libor-OIS EUR
Comdty Imp Vol Copper
Libor-OIS USD
ESTX50 Imp Vol
Govt-OIS USD
IG Corp CDS USD
Int Rate Imp Vol EUR
-0.07
CDS Index Skew EUR
-0.10
Basis Swap USDJPY
-0.29
-0.38
ESTX50 Skew
Nikkei Skew
-0.53
SP500 Skew
2 Global Equity Volatility Insights | 06 June 2017
Chart 3: Equity stresses fell by the most last week
Chart 4: Among regions, Japan & US stresses declined the most
0.1
0.0
-0.1
-0.2
-0.3
-0.4
-0.5
-0.6
-0.7
-0.8
-0.9
0.05 0.03 0.01
-0.02
-0.12
Commodities Credit FX Rates Equities
0.10
0.00
-0.10
-0.20
-0.30
-0.40
-0.50
0.02
-0.01
-0.05
-0.13
EM Europe US Japan
Latest stress (02-Jun-17)
Change in stress
Latest stress (02-Jun-17)
Change in stress
Source: BofA Merrill Lynch Global Research. 1wk change (26-May-17 to 2-Jun-17).
Source: BofA Merrill Lynch Global Research. 1wk change (26-May-17 to 2-Jun-17).
Chart 5: Top 10 movers in stress (1-week abs chg %-ile vs history*)
%-ile of abs chg in stress vs history*
100%
90%
80%
70%
60%
50%
86%
Nikkei Skew
83% 82%
SP500 Skew
Euro member
Bond Spread
76%
Libor-OIS USD
72%
CDS Index Skew
USD
IG Foreign Sovrn
Bond Spread
63% 61% 61% 61% 59%
ESTX50 Skew
Basis Swap
USDJPY
Stress fall
Stress rise
Libor-OIS JPY
Libor-OIS EUR
Source: BofA Merrill Lynch Global Research. * %-ile of weekly move in stress vs all historical weekly
moves (earliest 3-Jan-00). Bar colours represent rise (red) or fall (green) in stress. 1wk change (26-
May-17 to 2-Jun-17).
Chart 6: Global volatility & credit spread stress in the GFSI
0.4
0.2
0.0
-0.2
-0.4
-0.6
-0.8
-1.0
-1.2
-1.4
0.06 0.05 0.03 0.00
Sovrn risk
Latest stress (02-Jun-17)
Commodity Vol
FX Vol
Equity Vol
Change in stress
HY CDS
Source: BofA Merrill Lynch Global Research. 1wk change (26-May-17 to 2-Jun-17).
-0.01 -0.02 -0.03
IG CDS
Rates Vol
Global Equity Volatility Insights | 06 June 2017 3
Volatility in the US
How to trade the rise & fall of a potential Tech Bubble
“Alexa, has the Tech Bubble started?”
Our investment strategists recently warned against the risk of an overshoot in Tech,
noting that the longer it takes Central Banks to tighten, the greater the risk of Tech and
Growth stocks entering a speculative frenzy. Data on relative performance, valuation,
and flows are reminiscent to varying degrees of the early stages of a bubble:
• Market cap hegemony: Following the GFC, Tech stocks ousted Financials from
their top position in terms of market cap and now account for 23% of the S&P500,
the highest %-age from any single sector since the dotcom bubble (Chart 7).
• Dazzling growth vs. value outperformance: S&P 500 Growth stocks (SGX) on
aggregate cost ~1.4x as much as their Value counterparts (SVX), the largest
premium since the dotcom bubble (Chart 8). Notably, the S&P 500 Growth index is
dominated by Tech stocks, which account for 36% of its total market cap.
• Third longest streak of monthly gains: In May, the Nasdaq 100 recorded its
seventh consecutive monthly gain, the longest streak since 2009. Remarkably, the
index has managed to establish a longer streak only twice in its history, in 1986 (10
consecutive months) and in 1995 (8 months). The rally in these two episodes
ultimately came to an abrupt halt. However, the index would have substantial
further upside from current levels if it were to achieve similar gains (Chart 9).
• Lofty valuations: The valuation of Tech as measured by price to consensus forward
12M earnings expectations recently hit its highest value since Nov-07 and is
exhibiting signs of acceleration (Chart 10). However, Tech remains far cheaper than
its dotcom bubble highs.
• Irrational exuberance: Inflows to Tech funds are rising at their fastest annualized
rate (25% of AUM) in 15 years, a sign of renewed exuberance.
Chart 7: The last instance where a single sector dominated SPX market
cap as the Tech sector does now was the dotcom bubble era
35% Sector leadership in US equities
Chart 8: Growth has only been relatively more expensive vs. Value
during the peak of the dotcom bubble
1500
1.8
30%
1250
1.6
25%
20%
15%
1000
750
500
1.4
1.2
10%
250
1
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
2016
0
0.8
Tech
Financials
Discretionary
Industrials
Staples
Energy
Largest sector weight in the S&P500
Current = 95th %-ile
Source: BofA Merrill Lynch Global Research. Monthly data from Jan-1990 to Jun-17.
1995
1997
1999
2001
2003
2005
2007
2009
2011
2013
2015
2017
A / B (RHS) S&P Value (SVX) (B) S&P Growth (SGX) (A)
Source: BofA Merrill Lynch Global Research. Daily data from 30-Jun-95 to 5-Jun-17
4 Global Equity Volatility Insights | 06 June 2017
Chart 9: In May, the Nasdaq recorded its longest streak of monthly gains
since 2009 (7M). However, compared to the only other instances of
longer streaks (‘86, ‘95) the current bull run is still only half the size
Longest Tech Bull Runs with calendar monthly returns
160
150
140
130
120
110
100
90
80
2.3%
5.3% -0.3%
1.4%
1.4% -0.8%
5.7%
6.0%
5.6%
4.1%
10.2%
-2.9%
4.9%
0.5%
-11.1%
5.0% 3.9%
3.7%
2.7%
4.2%
9.2%
4.4%
= 100 as of 30-Sep-85
6.7% 3.4%
0.3%
= 100 as of 30-Dec-94
1.1%
0.2%
5.2% 2.0%
= 100 as of 31-Oct-16
Sep-85
Nov-85
Dec-85
Jan-86
Feb-86
Apr-86
May-86
Jun-86
Jul-86
Jan-95
Mar-95
Apr-95
May-95
Jun-95
Aug-95
Sep-95
Oct-95
Nov-95
Source: BofA Merrill Lynch Global Research. Data from Sep-85 to 31-May-17
Nov-16
Dec-16
Jan-17
Feb-17
Apr-17
May-17
May-86 Bull Run Oct-95 Bull Run May-17 Bull Run
Chart 10: Tech valuations seem to be gaining momentum and are now at
their highest levels since before the GFC but remain far from dotcom
bubble peaks
60
50
40
30