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Week in review & notable trends (US) US equities at new all-time highs on upbeat employment report Both the S&P500 and NASDAQ finished the week higher marking fresh all-time highs as the July nonfarm payrolls and average hourly earnings came in better-than-expected. As a result, VIX fell to its lowest levels since Jul-14 and the SPX ly vs. 1m ATMf implied vol spread 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 than the 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 of earnings decline since 2008. Earnings growth is now expected to resume in Q4-16. Chart 11: The SPX vol term-structure steepened materially on lower shorter dated implied vol with the lyr-1m ATMf implied vol spread reaching its highest level in almost 4 years 30% 29% 20% 15% 10% 5% 0% 5% mo Wo z= =< ———SPX tyr ATMf implied N oO > S << = mmm Spread A-B ———SPX 1m ATMf implied vol (B) Source: BofA Merrill Lynch Global Research. Daily data from 8-Aug-12 to 8-Aug-16. Nov-12 Feb-13 Aug-13 Nov-13 Feb-14 May-14 Aug-14 Nov-14 Feb-15 Nov-15 Feb-16 May-16 Aug-16 <= ol (A) Chart 12: Near multi-year flat call skew on Biotech (IBB) makes long call spreads an attractive option strategy to initiate or replace long positions to lock-in profits from the recent strong rally 55% 20.0% 50% 17.5% 45% 40% D A 15.0% 35% - 45th %-ile . in ee 12.5% 59, 10.0% 20% 7.5% 15% 5.0% 10% ; a 2.5% 0% 0.0% 2011 2012 2013 2014 2015 2016 mmm 5-day MA of spread A - B (RHS) IBB 1M ATM implied vol (A) ——— = [BB 1M 110 implied vol (B) Source: BofA Merrill Lynch Global Research. Daily data from 5-Aug-11 to 5-Aug-16. With SPX rallying on a stronger-than-expected July jobs report, SPX implied vol took a further leg down, especially in the shorter end of the vol curve. Indeed, SPX 1m ATMf implied vol ended 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 fall nearly as much causing a material steepening in the vol term structure. For instance, the lyr-1m implied vol spread reached its highest level since 27-Sep-12 (6.4 vol pts). Since its peak in Jul-15, the Biotech sector (NBI Index) has been on one of its worst runs in decades, underperforming the broad market benchmark (SPX) by a whopping ~30% on a total return basis. However, more recently the sector has regained some lost 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 a consequence of the recent rally, it still remains supported on a 5-yr basis. Also, upside vol has been richening vs. ATM vol, with the 1m IBB ATM-110 implied vol spread reaching its lowest level in five years on 4-Aug and finishing the week at 1.2 vol pts (3 5-yr %-ile). Investors with a constructive view on the sector who are concerned about a reversal of the recent gains should consider replacing or initiating long position via short dated ATM calls partially financed by expensive OTM calls. Bankof America Merrill Lynch Global Equity Volatility Insights | 09 August 2016 7 HOUSE_OVERSIGHT_025984