www.morganmarkets.comGlobal Equity Derivatives &Delta One Strategy
08 December 2011
Global Derivatives Themes
2012 Outlook for Equity Derivatives
Global Equity Derivatives & DeltaOne StrategyMarko Kolanovic
(1-212) 272-1438MKolanovic@jpmorgan.comJ.P. Morgan Securities LLC
(44-20) firstname.lastname@example.orgJ.P. Morgan Securities Ltd.
Tony SK Lee
(852) email@example.comJ.P. Morgan Securities (Asia Pacific) Limited
(81-3) firstname.lastname@example.orgJPMorgan Securities Japan Co., Ltd.
See page 41 for analyst certification and important disclosures, including non-US analyst disclosures.
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In 2011 we witnessed two distinct market regimes: very low volatility inH1, and extreme correlation, poor liquidity and high volatility in H2.Escalation of European sovereign credit crisis in August caughtinvestors by surprise,triggering a series of large risk on/off flows. Therecord drop in equity liquidity and the rise of cross-asset correlationseffectively shut off equity markets for fundamental stock investors. Inaddition, derivative hedging flows at times overwhelmed liquidity,further adding to market volatility and correlation.
Political risk is currently the main driver of market volatility.Uncertainty related to the European monetary and fiscal policies hasdisadvantaged holders of risky assets. In addition, the capacity of thefinancial system to store risk has been diminished by ongoingdeleveraging and by regulatory changes that have eliminated proprietarydesks and increased the cost of capital. The diminished risk-takingcapacity has resulted in large dislocations in implied correlation, skew,convexity, long-dated volatility, and dividend markets.
In 2012, we expect a decline in volatility relative to H2 2011. Despitelingering macroeconomic, political and geopolitical risks, we believe thatcyclical forces willlikely reduce what we believe are unsustainablelevels of correlation and risk premium. We recommend that investorsimplement trades that have a short skew, short correlation and shortconvexity bias, as these metrics are all currently expensive, in our view.
In the second part of this report, we recommend a number of trade ideasthat incorporate our market and volatility views. In particular, we suggestthe following:
Risk Premium Trades–
sell index skew through putladders, put ratios and barrier options; sell convexity on the Nikkei 225and Hang Seng; sell correlation on the ASX 200, FTSE 100 andS&P500; sell long-term variance on the S&P 500; long protected upsideon 2013 EuroSTOXX50 dividend futures;
hedge risk-off events with selected global index puts; hedgegeopolitical risk with “Iran puts”(S&P 500 puts contingent on oil pricesrising); hedge volatility risk with May-12 VIX call spreads; hedge HongKong bank risk with a best-of put;
Relative Value Trades–
sellS&P500 variance,buy KOSPI variance; EM vs. DM outperformance;and European single-name credit-equity trades;
Upside ParticipationTrades –
buy OTM calls on derated names in Europe; bullish Japancalendar spreads.