For the final presentation of the second day at CBOE RMC Europe, Abhinandan Deb from Bank of America Merrill Lynch and Michael Stephens from Pioneer Investment Management split duties to discuss Global Volatility Trading Opportunities with a Focus on Europe.
Their talk spent some time discussing the fallout from Brexit and potential market fragmentation risk along with geopolitical and central bank risk. They also discussed the impact of structural investor flows and strategies to gain alpha and manage risks.
It was noted that the global equity markets do not appear to be discounting much risk to performance. Stated more plainly, volatility does not explain the real risk of managing assets. Central banks appear to be focusing more on the markets than the actual economic outlook. The result is whenever there is a tantrum in the equity markets the result is a central bank response that calms the markets. The risk is when central banks run out of ammo or market participants begin to lose confidence in central banker’s ability to effectively intervene.
The spread between implied volatility on the Euro Stoxx 50 and S&P 500 was discussed with an observation being that Euro Stoxx 50 vol is cheap relative to S&P 500 vol. The idea is to find a way to be long Euro Stoxx 50 vol and short S&P 500 vol. I had a chance to speak to one of the presenters after the session and asked if this outlook also had a fundamental basis, that is that EU economic conditions are more at risk than the US. His feel was that is the case as well as there being a difference between volatilities.
The effectiveness of hedging with broad based index put options was discussed with a look at how often various puts are in the money at expiration. It was noted that over the last 10 years a 30 day ATM SPX Put would expire in the money 36% of the time. This means that it would have not value 64% of observations. However, when in the money the ATM put had a value that was twice as much as the starting market value. A similar study was run using Euro Stoxx 50 options and it was shown that a 90-day 5% OTM Put on the Euro Stoxx 50 expires in the money 22% of the time on average, when in the money, has a premium that is 3 times that of the initial price.