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Chart 7: A combination of upward trending global equity markets and
very low volatility have conspired to push trend following (CTA) equity
positioning to near record levels. Consequently, the beta of CTA
strategies to global equities is also at extreme levels
Chart 8: Owing to low cross asset vol and strong diversification, the
volatility of risk-balanced multi-asset portfolios has fallen to historically
low levels. Consequently, leverage levels across multi-asset & other
portfolios that target fixed vol have likely hit their caps
1.00
0.75
0.50
0.25
0.00
-0.25
-0.50
-0.75
-1.00
DWM
WoW
wm
mW OO
O
OHO Oo Oh
~-
+
e¢s
Ss
eogeeR SBsxeaeBEeE
RK DS
ofS eS
608
TSOSEaBHXS
72.2 Ss
ao7r 7S
Ss
oz
7 S>s5
mt MSCI World (Ratio of trend strength to volatility) (LHS)
——— BofAML Model CTA Global Equity Allocation (RHS)
Source: BofA Merrill Lynch Global Research. Based on daily data form 2-Jan-2015
to 16-Jun-2017.
CTA = Commodity Treding Advisor
24%
Ay)
7
a
wy
3.0X
20%
2.5X
16%
2.0Xx
12%
1.5x
8%
1.0x
4%
0.5x
0%
0.0x
1972 1975 978 981 984 987 990 993 996 999 2002 2005 2008 2011 2014 2017
mmm Model Risk Parity Leverage {Vol Target: 10% & Max Leverage: 3x) (RHS)
Unlevered BofAML Model Risk Parity Volatility (LHS)
Source: BofA Merrill Lynch Global Research. Based on daily data from 3-Jan-72 through 16-Jun-17.
Equity, fixed income, and commodity components within the hypothetical risk parity investment are
represented by the S&P500, 10-Year US Treasury Bonds, and the S&P GSCI Index, respectively. Risk
parity ellocations are determined and redalenced monthly using prior 12-month realized volatility
and correlations.
It is important to note that not all CTA, risk parity, or vol control strategies operate
similarly and there is model risk in estimating the exact size of these trading flows.
Chart 9: The vega outstanding in inverse VIX ETNs has also reached a
record high at ~$125mn vega
Chart 10: Global FMS average cash balances (%) remain elevated,
suggesting dry powder for investors still conditioned to buy equity dips
350
300
290
200
== Unlevered long
«=== Levered long —
ee |Verse
_ ease
Net vega across VIX ETPs
VIX
ETP
open
interest
($mn
vega)
8
-100
-150
2012
2013
2014
2015
2016
2017
Source: BofA Merrill Lynch Global Research. Daily data from 13-Feb-12 through 16-Jun] 7.
I
!
2400
6.0%
Backtest
Actual
2200
2000
1800
1600
1400
1200
1000
800
600
5.5%
5.0%
45%
4.0%
3.5%
3.0%
‘OL '02 ‘03 ‘04 ‘05 ‘06 ‘07 08 ‘09 10 11 ‘12 '13 '14 15 16 ‘17
FMS avg cash balance (%)
—
S&P 500 (RHS)
Source: BofA Merrill Lynch Global Fund Manager Survey, Bloomberg. As 2 reminder, the FMS Cash
Rule works es follows: when average cash balance rises above 4.5% a contrarian buy signal is
generated for equities. When the cash balance falls below 3.5% a contrarian sell signal is generated.
Extract risk-limited alpha from SPX range via cheap in-the-money knockout puts
As a risk-limited range trade, we like owning down-and-out puts on SPX that are already
in-the-money. For example, the SPX Sep 2475 put with a 2300 knock-out (continuous
observation) indicatively costs 7Obps (spot ref 2451) and offers a 60% discount to the
vanilla 2475/2300 put spread, which is itself historically cheap (Chart 12).
If SPX stays above the 2300 barrier at all points in time before expiry, the structure is
equivalent to a 2475 put option. If the barrier is instead breached, the maximum loss
will be equal to the (low) upfront premium. The 2300 barrier is about 6% out-of-the-
money, hence “allows” for the elusive 5% correction not seen since Brexit (on a closing
basis). However, investors can mitigate the risk of breaching the barrier by either
moving it farther down (e.g., a 2245 barrier would indicatively raise the cost from 0.7%
to 1%), or by only observing it on a close-to-close basis (in turn sacrificing part of the
discount).
BankofAmerica
Merrill Lynch
Global Equity Volatility Insights | 20 June 2017
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