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Chart 7: A combination of upward trending global equity markets and very low volatility have conspired to push trend following (CTA) equity positioning to near record levels. Consequently, the beta of CTA strategies to global equities is also at extreme levels 1.00 0.75 0.50 0.25 0.00 -0.25 -0.50 -0.75 -1.00 Ke) WwW io) ie} > oO fom ® wo > fom & ® = ip) Jul-15 Nov-15 Jan-16 Mar-16 Jul-16 Nov-16 Jan-17 Mar-17 May-17 wo to 5 & 37 S= 5S mmm MSCI World (Ratio of trend strength to volatility) (LHS) ——— BofAML Model CTA Global Equity Allocation (RHS) Source: BofA Merrill Lynch Global Research. Based on daily data form 2-Jan-2015 to 16-Jun-2017. CTA = Commodity Trading Advisor Chart 8: Owing to low cross asset vol and strong diversification, the volatility of risk-balanced multi-asset portfolios has fallen to historically low levels. Consequently, leverage levels across multi-asset & other portfolios that target fixed vol have likely hit their caps 24% 3.0X 20% 2.9X 16% 2.0X 12% 1.5x 8% 1.0x 4% 0.5x 0% 0.0x NwoOortHRemeAnNnaorwtnr KCK R DBDHADADBDHAASDS LAS BAADABARBAAAASSSSSS mmm Model Risk Parity Leverage (Vol Target: 10% & Max Leverage: 3x) (RHS) Unlevered BofAML Model Risk Parity Volatility (LHS) Source: BofA Merrill Lynch Global Research. Based on daily data from 3-Jan-72 through 16-Jun-17. Equity, fixed income, and commodity components within the hypothetical risk parity investment are represented by the S&P500, 10-Year US Treasury Bonds, and the S&P GSCI Index, respectively. Risk parity allocations are determined and rebalanced monthly using prior 12-month realized volatility and correlations. It is important to note that not all CTA, risk parity, or vol control strategies operate similarly and there is model risk in estimating the exact size of these trading flows. Chart 9: The vega outstanding in inverse VIX ETNs has also reached a record high at ~$125mn vega 350 ee J nlevered long === Levered long 300 ee |nverse === Net vega across VIX ETPs 250 200 150 100 VIX ETP open interest ($mn vega) -150 2012 2013 2014 2015 2016 2017 Source: BofA Merrill Lynch Global Research. Daily data from 13-Feb-12 through 16-Jun1 7. Chart 10: Global FMS average cash balances (%) remain elevated, suggesting dry powder for investors still conditioned to buy equity dips I 2400 6.0% Backtest 1 Actual 2200 5.5% 2000 if I 5.0% 1800 1600 a 1400 4.0% 1200 1000 G, 3.5% se 3.0% 600 ‘01 ‘02 ‘03 '04 '05 '06 ‘07 ‘08 09 10 11 12 13 '14 15 16 17 FMS avg cash balance (%) — S&P 500 (RHS) Source: BofA Merrill Lynch Global Fund Manager Survey, Bloomberg. As a reminder, the FMS Cash Rule works as follows: when average cash balance rises above 4.5% a contrarian buy signal is generated for equities. When the cash balance falls below 3.5% a contrarian sell signal is generated. Extract risk-limited alpha from SPX range via cheap in-the-money knockout puts As a risk-limited range trade, we like owning down-and-out puts on SPX that are already in-the-money. For example, the SPX Sep 2475 put with a 2300 knock-out (continuous observation) indicatively costs 7Obps (spot ref 2451) and offers a 60% discount to the vanilla 2475/2300 put spread, which is itself historically cheap (Chart 12). If SPX stays above the 2300 barrier at all points in time before expiry, the structure is equivalent to a 2475 put option. If the barrier is instead breached, the maximum loss will be equal to the (low) upfront premium. The 2300 barrier is about 6% out-of-the- money, hence “allows” for the elusive 5% correction not seen since Brexit (on a closing basis). However, investors can mitigate the risk of breaching the barrier by either moving it farther down (e.g., a 2245 barrier would indicatively raise the cost from 0.7% to 1%}, or by only observing it on a close-to-close basis (in turn sacrificing part of the discount). Bankof America Merrill Lynch Global Equity Volatility Insights | 20 June 2017 5 HOUSE_OVERSIGHT_014976