EFTA02377374.pdf

From: Ens, Amanda Sent: Thursday, April 20, 2017 1:51 PM To: jeffrey E.; Richard Kahn Subject: Buy cheap downside: SPX puts contingent on rates Jeffrey, Rich, Given the current macro uncertainty, large recent move in rates, high correlation between SPX and l0y yields and resilience in equities, to the extent you still have long equity positions, we like buying SPX puts contingent on higher yields, which price at significant discounts vs vanilla puts. In this example, we need the l0y swap to get back above - 2.35%, which is not a high bar considering it was above 2.50% just last month. * Sep 15th 95% Put contingent on l0y constant maturity swap rates (CMS) > ATMF +10bps (2.35%) at maturity: 74 bps offer, 61% discount to vanilla put Rationale: 1. Recent economic data has been disappointing (march NFP, inflation, etc) and that has dragged yields lower. Over last month, 10yr yields have come in - 40bps — 2.16% now. It would take only a quick string of better data (and the bar is low!) for 10yr rates to sell off a bit (higher in yield) 2. SPX has been resilient during this period: down only 2% from all-time high in early March but this iron-clad performance should be hedged Catalysts: Over the coming weeks and months, SPX faces several headwinds — geopolitical risks (French elections, Syria, North Korea), domestic policy uncertainty (tax reform, protectionism) as well as earnings expectations for 01. Meanwhile, the Fed has started talking about shrinking its balance sheet, which should support 5-10yr yields even if risk got re-priced in the equity market. Favorable Pricing SPX/USSW10 implied correlation is still high: —30%; above recent realized (graph below) I EFTA_R1_01387835 EFTA02377374 Investors worried about a pull-back in equities can leverage this correlation to get significant discount vs SPX puts. Trades: Sep 15th 95% Put contingent on l0y constant maturity swap rates (CMS) > ATMF +10bps (2.35%) at maturity: 74 bps offer, 61% discount to vanilla put Sep 15th 95% Put contingent on l0y CMS > ATMF +25bps (2.50%) at maturity: 55 bps offer, 70% discount to vanilla put Dec 15th 95% Put SPX put contingent on l0y CMS > ATMF +25 (2.54%) at maturity: 88 bps offer, 69% discount to the vanilla We can easily price other strikes, maturities and iterations. SPX/USSW10 90 day daily realized correlation Source: Bloomberg Amanda Ens Director Bank of America Merrill Lynch Merrill Lynch, Pierce, Fenner & Smith Incorporated One Bryant Park, 5th Floor, New York, NY 10036 Phone: 2 EFTA_R1_01387836 EFTA02377375 This message, and any attachments, is for the intended recipient(s) only, may contain information that is privileged, confidential and/or proprietary and subject to important terms and conditions available at http://www.bankofamerica.com/emaildisclaimer. If you are not the intended recipient, please delete this message. 3 EFTA_R1_01387837 EFTA02377376