The current market environment is characterised by a higher degree of uncertainty than usual. Two main factors contributing to this:
- Headline risk from political tension between China & US
- Uncertainty regarding US Economic outlook
Yuan has been a driver of risk sentiment in the past, and since further hardening of fronts in trade dispute make an imminent resolution unlikely. However, potential of renewed Fed stimulus may cause continued rally in stocks driven by liquidity.
Rationale Behind This Trade
The recent spikes in market volatility and headline risk led to increased downside hedging. Put skew (=difference of volatility between a call and a put option) has therefore increased. This presents an opportunity for Investors to switch from Equity long positions into a synthetic long through buying a call and selling a put option, picking up above average premium.
The overall Equity Risk position is slightly reduced but gives investors some downside buffer, while participating on upside moves.
In the following trade idea, we show an example of a Bond plus Index option structure versus the outright index. The solution can be customised to your needs and preferences regarding choice of Bonds, underlying or tenor of options. Can be used either for slight risk reduction if underlying position is sold first, or as additional long risk but with a slight buffer to the downside.
Working Example: S&P Future Options + Corp Bond
- Client is long 1 Unit of S&P 500 E-mini index, and sells position
- With proceeds, purchase 1 Unit long of : Corporate Bond, minimum Rating BBB, max Duration 7yrs, Yield 4.3%
- Buy 1 Unit of S&P 20. Dec 2019 Call Strike 3,000 – Indicative Cost – $ 2,925
- Sell 1 Unit of S&P 20. Dec 2019 Put strike 2,700 – Indicative receipt
+ $ 3,812
Requirements & Important Points to Note
- Minimum Sophistication Level: 9
- Minimum Size: USD 150,000 equivalent
- Accredited Investors only
- The above stated Return and P&L assumptions are based on static bond prices, but there will be differences due to correlation between stock prices, bond yields and corporate bond spreads
- All numbers are for demonstrative purposes and actual returns may vary substantially
- Above scenarios are based on certain correlation assumptions between different asset classes, which may not persist in the actual market environment
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