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Europe Market Commentary 25 November 2009
Derivatives Strategy
Exhibit 1: IP Momentum per region Exhibit 2: SX5E 3-month 90%/110% volatility skew
Avg: 7.48%
+2 Std: 10.70%
-2 Std: 4.27%
30-Dec-04 30-Dec-05 30-Dec-06 31-Dec-07 30-Dec-08
5.00%
7.50%
10.00%
Vola
tility
(%)
SX5E Skew Avg(SX5E Skew) ±2*Std(SX5E Skew)Source: Credit Suisse Locus
Derivatives Strategy Stanislas Bourgois, CFA + 44 20 7888 0459
Raymond Hing + 44 20 7888 7247 Sell Equity skew into year-end
! Phase 1 of economic recovery is usually sharp, brief, and followed by a renewed decline. But normally, that's the base for a second, more sustained rise if and when retail sales/final demand growth picks up ("Phase II of recovery"). According to Credit Suisse Strategist Jonathan Wilmot, the inter-phase is typically associated with weaker, choppier returns to risky assets in favour of an outperformance by government bonds.
! Global Industrial Production momentum hit its peak in October and is now slowing (Exhibit 1). Before a hypothetical �Phase II� kicks in, ISM New Orders are likely to trend lower, having already fallen for two consecutive months, leaving markets in the difficult interim between Phase I and Phase II of recovery for some time.
! This new environment has been reflected in Equity performance since the beginning of September: cash Equity�s risk reward has deteriorated, with range-bound markets sending Equity�s information ratio (the ratio of average daily P&L to standard deviation) to only one fifth of what it was during the initial market rally.
! However we believe that the macro environment is still supportive for risk. Credit Suisse�s Economic Surprise index is still positive. Europe and the Americas are still going through the most intense phase of recovery and a slowdown in growth momentum in these regions still seems weeks away (peak in IP momentum there is expected in December).
! We believe that selling the skew could be an interesting alternative to other risky trades into year-end. In vanilla terms, selling the skew involves selling puts while buying call options (a risk reversal) � an interesting trade when downside implied volatilities are high versus the upside, as is the case now (Exhibit 2) but a risky one when an adverse market move creates a strong demand for put protection and implied volatilities are remarked up.
! As shown on Exhibit 3 next page, selling vanilla skew has been one of the great trades of 2009. Since September, range-bound markets have actually increased the attractiveness of short skew trades while cash Equities� risk reward plummeted � with the exception of early November for the SPX, where an adverse move on SPX volatilities created temporary mark-to-market losses (for more on early November VIX moves, please refer to our US colleague Ed Tom�s Unraveling the recent VIX volatility, dated 13 November).
! One reason for the good performance of short skew is that Equity markets still behave as if underinvested/long protection. Open interest for SX5E call options, which surged in early Q2 because of put spread collar trading, has been roughly unchanged since then (Exhibit 4). Conversely, total put open interest has gradually increased as put positions were rolled up as the market rallied, leaving long-Equity investors well protected and limiting the risk for panic volatility buying on market weakness. This results in lower realised volatility, vol of vol and vol/equity correlation, an environment in which short skew positions typically thrive (see our detailed analysis Trading the Volatility Skew, dated Nov 2008). The SPX experience in November shows that selling the skew starts being dangerous only on days when Equity markets fall by almost 3% - close to 50% realised volatility when Equity index currently realise roughly 20%.
NOTE: The risk of selling uncovered put options can be substantial and may result in losses significantly greater than the premium received.
Derivatives Strategy
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Exhibit 3: Systematic 3M, 90/110 risk reversal (delta hedged, monthly rebalanced, 1m notional))
Exhibit 4: SX5E Dec09 Call Open Interest
-1,000,000
-500,000
0
500,000
1,000,000
1,500,000
2,000,000
2,500,000
3,000,000
3,500,000
02/01/09 27/03/09 19/06/09 11/09/09
FTSESTOXX50ESPX
Cum
ulat
ive
Per
form
ance
0
1,000,000
2,000,000
3,000,000
4,000,000
5,000,000
6,000,000
08/12/08 02/03/09 25/05/09 17/08/09 09/11/09
'1800 '2000 '2200
'2400 '2600 '2800
'3000 '3200 '3400
Source: Credit Suisse Derivatives Strategy
Exhibit 5: SX5E Dec09 Put Open Interest
1,500,000
2,000,000
2,500,000
3,000,000
3,500,000
4,000,000
4,500,000
5,000,000
5,500,000
6,000,000
08/12/08 02/03/09 25/05/09 17/08/09 09/11/09
'1800 '2000 '2200
'2400 '2600 '2800
Source: Credit Suisse Derivatives Strategy
Derivatives Strategy
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Credit Suisse Derivatives StrategyEuropeStanislas Bourgois CFA +44 20 7888 0459 [email protected] Hing +44 20 7888 7247 [email protected]
USAEdward K. Tom +1 212 325 3584 [email protected] Palsson +1 212 325 6331 [email protected]
Credit Suisse Europe Equity Derivatives Sales
Tom Teague (Head) +44 20 7888 4792 [email protected]
UK and US Institutions/Hedge FundsSimon Munroe +44 20 7888 2752 [email protected] Clavel Flores +44 20 7888 6528 [email protected] Killion +44 20 7888 4781 [email protected] Bayar +44 20 7888 3533 [email protected]
Germany/ScandinaviaOliver Groeteke +49 69 75 38 2124 [email protected] Bombe +49 69 75 38 2122 [email protected] Faust +49 69 75 38 2123 [email protected] Anden +44 20 7888 6810 [email protected]
France/BeneluxDavid Cohen +44 20 7888 0773 [email protected] Arhab +44 20 7888 6221 [email protected] Bouaziz +33 1 70 39 01 12 [email protected]
ItalyVincenzo Spadaro +44 20 7888 2730 [email protected] Mammoliti +44 20 7888 0784 [email protected] Lodi-Rizzini +44 20 7888 3318 [email protected]
IberiaMaite Suarez +34 91 423 16 51 [email protected]
Emerging MarketsSteve Jobbber +44 20 7888 6912 [email protected] Bezuglaya +44 20 7888 0913 [email protected] Larcheveque +44 20 7888 0913 [email protected]
Structured/Hedge FundsMatt Shelton +44 20 7888 7032 [email protected] Hoefling +44 20 7888 4248 [email protected]
Listed Sales & TradingNathaniel Foster +44 20 7888 4427 [email protected] Carr +44 20 7888 3473 [email protected] Arshad +44 20 7888 1776 [email protected] Taank +44 20 7888 5665 [email protected] Philipps +44 207 888 1364 [email protected] Brown +44 20 7888 0248 [email protected]
