Global Equity Volatility Insights: The necessary shock

Key takeaways 

 

•         S&P put spreads to hedge fading fiscal & Fed policy into the fall; high vol, flat call skew favor call ratios for AAPL upside

•         Fears of a second wave of COVID infections rise in Europe as vol & skew levels make year-end core and tail hedges compelling

•         A comeback of Asian autocall issuance in the months ahead could put downside pressure on long-dated Nikkei & HSCEI vol & skew

 

 

 

INTERACTIVE ANALYTICS 

   

 

 

Can the market keep its balance without policy training wheels this fall?

 

As markets continue their steady climb, two key engines of the rally may be running out of steam. The first is fiscal support - the critical but expired unemployment extension is unlikely to be restored soon. The second is the Fed, which stopped growing its balance sheet in June, deemed yield curve control a no-go last week, and faces new chances to step off the gas in Jackson Hole (27-Aug) and the Sep FOMC. Even if the Fed stands ready to act again, it will likely be in response to a market shock, which also looks needed to break the fiscal logjam. Hence, perversely, a shock looks increasingly necessary to force policy measures allowing the market to sustain these levels to begin with. As a near-term quite attractive hedge, S&P Sep 3350/3150 put spreads leverage extreme skew and offer a 9-to-1 max payout. We also reiterate put ratios on gold, which remains most at risk of a policy shock.

 

How to embrace a potential blow-off top in Apple

 

Perceived as beneficiaries of the post-Covid economy, large cap tech stocks have rallied off the pandemic lows. Apple, however, has seen a particularly strong outperformance versus its peers. Indeed, its market cap has surged to over $2tn (the largest company in the world), and its 12m trailing PE ratio has climbed to a 12-year max. The strong rally in Apple saw an abnormally strong 'vol up-spot up' dynamic, that, over the past 10yrs, has almost never before been displayed to the same degree. Additionally, upside vol has risen even faster vs ATM vol-a sign of upside chasing via calls-pushing call skew to historically flat levels. As such, 1x2 call calls ratio (+/-) set up attractively to monetize both elevated vol/flat skew. Buying the Oct20 565/650 1x2 call ratios costs 72bps. Notably, the overlay only starts to underperform a long stock position if AAPL rallies >45% by expiry, an unprecedented performance outside the Tech bubble, given the already strong returns.

 

Consider 'Core' and 'Tail' hedges for European risks

 

Concerns of an upcoming second wave of COVID infections in Europe and an associated economic slowdown, coupled with the recent PMI disappointment serve as a reminder that the path towards full recovery may still see risk episodes that trigger higher volatility and market weakness. The currently lower vols, steep skews in European indices and the relative softening of the ESTX50 wings offer an opportunity to lock-in year-end hedges for moderate and extreme sell-offs using attractively priced put spreads and delta-hedged short put ratios.

 

Asia autocalls: Here comes the knock-outs

 

In the wake of the stock market recovery, Korean autocalls are finally ready to start knocking out again. This should lead to an increase in new issuance which in turn could start pushing longer dated vols and skew lower in the months ahead. Dec-21 put vols on the Nikkei and the HSCEI have barely moved since early April and remain 4-5% above pre-covid levels (having retraced ~55-70% of the March spike).