HOUSE_OVERSIGHT_014990.jpg

Chart 27: Both HSCEI and NKY term structures are near record steeps; we favor calendar puts to hedge downside risks 15% 10% 5% 0% -5% ex 2 oO OO TT NN OO TT OO OO O SSSSESESESESE8S5 55 ————NKY 3M-12M ATM Vol = === HSCEI 3M-12M ATM Vol Source: BofA Merrill Lynch Global Research Data as of 2-Jan-09 to 16-Jun-17 Chart 28: The Nikkei/Topix ratio and its volatility is capped with the Bo)’s ongoing yield curve control , O06 5 2.9 04 3 Fs 27 02 § g 12.5 0 = & 12.3 02 3 > 04 2 a 12.1 By a 1 06 a os © = 117 , @ 4 11.5 # 1.2 NNN OO MO DS BD tO DO O Oo - eee rEeerrere a=—=NKY/TPX Ratio == 10Y JGB Yield Source: BofA Merrill Lynch Global Research Data from 2-Jan-12 to 16-Jun-17 AS51 3M ATM IV over HSCEI is at its 4-year high Table 4 lists Asian index pairs with the highest IV ratio vs their 4-year histories. For instance, the ratio of AS51 3M ATM IV over HSCEI is at its 4-year high. Calendar puts are attractively priced given the steep term structure With the continuous low realized volatility environment, both NKY and HSCEI 3-month minus 12-month term structures steepened to -3.7 vol points, which are near multi-year lows. As our strategists think the Fed now appears concerned about surging asset prices, investors should consider downside hedges. Calendar puts, i.e. buying short-dated ATM puts and selling long-dated OTM puts, are attractively priced given the steep term structure. Currently, we still have an open trade on NKY calendar puts (buy Jul-17 19,500 puts vs sell Dec-17 17,500 puts) to hedge downside risks. The Bo)’s ongoing yield curve control has capped the Nikkel/Topix ratio and its volatility Japanese government bond (JGB) yield has been on a downward trend over the last few years and has negatively impacted bank earnings. As the Topix has higher weightings in banks than the Nikkei, the NKY/TPX ratio has been grinding higher. However, the NKY/TPX ratio appears to have flattened out since the Bo}’s commitment to maintain the 10-year JGB yield at around 0% in September 2016. With global central banks increasingly advocating tighter monetary policies, the market may start to speculate Bo)’s exit strategy and this may reverse NKY/TPX’s upward trend. With TPX vol trading below NKY vol, buying TPX calls funded by NKY calls may perform well in such a scenario. Bankof America Merrill Lynch Global Equity Volatility Insights | 20 June 2017 19 HOUSE_OVERSIGHT_014990