EQUITY DERIVATIVES STRATEGY

Market Commentary
January 7, 2015

2015 Equity Volatility Outlook

Ragin Contagion
Equity Derivatives Strategy

The US equity market enters 2015 on shaky Exhibit 1: S&P Expected Volatility Scenario Analysis
footing. While the intrinsic landscape looks relatively
benign, with strong fundamentals buttressing index S&P Level at Realized Vol
S&P Return
End of Period Forecast
levels that are still near all-time highs, risks have started
to surface in other asset classes. Indeed, the 1st Half 2015 2250 9.3% 13.1%
derivatives markets for commodities, FX, rates, and 2nd Half 2015 2200 -2.2% 14.9%
sovereign credit have already started pricing in wider
spreads and higher volatility. Ultimately, the impact of Full Year 2200 6.9% 14.0%
these cross-asset catalysts will be determined not only
by the intensity of the surprise but also by the Source: Credit Suisse Equity Derivatives Strategy
resiliency of the equity market to withstand the effects
of cross-asset volatility contagion. Exhibit 2: A Steady-State VIX Forecast at 18
Over the course of this report, we explain the rationale
for our 2015 volatility outlook: a steady state forecast
of VIX at 18, but with increased tail risk (i.e., kurtosis
premium) precipitating macro shocks that could drive
the VIX to excess of 30.

Our report is divided into four parts:

1) Volatility: In the first section, we define our level for

baseline realized volatility by analyzing relevant
underlying economic fundamentals. We then examine
potential macro catalysts such as a Russia default, a Source: Credit Suisse Equity Derivatives Strategy
euro breakup, and a shock stemming from the interest
rate market all of which will likely inflate the premium Exhibit 3: Sector Volatility Outlook for 2015
accorded to implied volatility over baseline volatility.
2) Skew & Term-Structure: In the second segment, we
discuss investment trends in the derivatives markets to
determine how the supply and demand for volatility
from hedge funds, institutions, insurance companies,
pension funds, and retail investors shape our views for
index volatility skew and term structure.
3) Sector Volatility & Correlations: In the third part, we
discuss developing themes within the specific sectors
that are likely to influence volatility at the single-stock
level and how these changes could affect inter-stock
correlations.
4) Trade Recommendations: Finally, in section four, we
wrap up by proposing trades that best reflect our views. Source: Credit Suisse Equity Derivatives Strategy
Edward K. Tom Stanislas Bourgois, CFA Mandy Xu, CFA Alexis Keister Nicolas Dumoulin
[email protected] [email protected] [email protected] [email protected] [email protected]
(212) 325 3584 +44 20 7888 0459 (212) 325 9628 (212) 538 4505 +44 20 7888 5356

(212
(
 EQUITY DERIVATIVES STRATEGY

2015 US Equity Volatility Outlook

Executive Summary 3

Index Volatility Outlook 4

Establishing Baseline Volatility 4

Potential Tail Catalysts (Kurtosis) 6

Russias Groundhog Day: 1998 Again? 7
Europe: Political Contagion is the Key 10
Ragin Contagion: Rising Rates Pose a Risk 11

Volatility Supply and Demand: Skew & Term Structure Outlook 13

Institutional/Fundamental Long/Short 17
Volatility Hedge Funds 18
Insurance Companies 19
Pension Funds 21
Structured Products 22
Systematic Investment Strategies 24

Summary: VIX Forecast For 2015 25

Sector Volatility Outlook 26

Key Sector Volatility Views 26
Energy: Oil Vey! 27
Technology: Growth Spurt Intact 30
Healthcare: Catalysts Galore 31
European Sector Volatility Outlook 32

Correlation Outlook 34
The Divergence Between Inter- and Intra-Sector Correlations 37

Trade Recommendations For 2015 52

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 EQUITY DERIVATIVES STRATEGY

Executive Summary Framework for Analyzing Volatility

Baseline Volatility: Equity market looks to be at a Our discussion will utilize a framework that decomposes
cross-road as we enter 2015. US economic implied volatility into 3 components:
growth is accelerating just as the Fed gets set to
1. Baseline volatility Our expectations for realized
embark on its first rate hike in almost a decade.
volatility driven by economic fundamentals;
Weighing these risks, our Global Equity Strategy
team sees a positive first half for equities with a 2. Kurtosis - The excess premium volatility traders
risk of a correction in the 2nd half of the year. charge to account for the uncertainty of tail-events;
Taken together, they have a year-end target of
3. Skew The excess premium implied volatilities
2200 for the S&P. Using that target level, we
trade above realized owing to the supply and
forecast a baseline S&P realized volatility of 14.0%
demand for volatility as an asset class.
for 2015.
Potential Volatility Shocks: From a Russian debt
Illustration of Volatility Framework
default circa 1998 to a euro breakup, there remain To illustrate this technique, we apply the methodology
a number of macro catalysts that could drive to the VIX at four instances in 2014: July 3rd (lowest
implied volatility up to the 30-40 range. Contagion reading at 10), Oct 15th (highest reading at 26), and
risks have caused option investors to embed a two instances when the VIX was at the same level (Feb
larger than usual kurtosis premium to the VIX. 4th and Dec 31st).
Volatility Supply & Demand: Anticipated macro Exhibit 4: Example Decomposition of VIX in 2014
shocks will likely manifest via skew and increase its
shock sensitivity. Against this backdrop, an
escalation in institutional repositioning, resurgent
volatility hedge fund interest in tail asymmetry, and
adaptations to hedge rising insurance gamma
sensitivities should increase skew convexity.
Absent a material uplift in global yield, structured
notes will gravitate toward increasingly longer dated
maturities resuscitating liquidity at the back-end
of the implied volatility term structure.
Sector Volatility & Correlations: While Source: Credit Suisse Equity Derivatives Strategy

correlations are determined by co-movements at The sample decomposition above shows two notable
the single stock level, there are three sectors S&P developments. First, as one would expect, the premium
dispersion traders should focus on in particular: stemming from the supply and demand for volatility
Energy, Tech, and Healthcare. We believe Energy (skew) and tail risk (kurtosis) were significantly higher
and Healthcare sector volatilities will move higher in during the October sell-off, with both kurtosis and skew
2015, while Tech should see a decline in vol. On premiums doubling from their July lows. Secondly,
correlation, we expect a significant pickup in although we exit 2014 at the same VIX level as earlier
implied correlation as a result of our macro risk in the year (Feb 4th), the skew premium is 0.5 pt higher
outlook. (2.4 vs. 1.9) as demand for hedges have increased.

2015 Trade Recommendations

Top Macro Ideas Top Thematic Ideas

Bearish euro with FXE put spread collar Europe over US outperformance
Hedge Russia default risk with RSX downside Buy oil up-and-out call
S&P put contingent on 5yr rate above 3% Buy energy vol; sell oil vol
Position for QE in Europe with call spreads Buy energy down-and-in call
Yield enhancement with short straddles Sell tech vol

***Risks: The risks to buying a put, a call or a put or call spread is limited to the premium paid. The risk to selling a put can be significant. The risk of selling a
call can be unlimited. The risk to selling a variance swap or straddle could be unlimited. The risk to buying a variance swap is that variance could go to zero.

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 EQUITY DERIVATIVES STRATEGY

Establishing Baseline Volatility Bootstrapped Monte-Carlo

Baseline volatility, the type inherent in a liquid, continuous Calculate forecasted S&P return target
market, is largely a function of underlying economic Calculate daily historical returns for S&P-500 from 1928 to
fundamentals. With that in mind, as we look ahead to the present (21,851 data points)
2015, there are still many reasons for equity investors to
feel optimistic. Calculate rolling-window of 6-month daily compounded
returns (21,725 data points)
Coming on the heels of its best quarterly growth in over a
Create a distribution of returns by collecting every instance in
decade, the US economy is projected to expand another which a 6-month price path results in a return equal to our
3% in 2015. The labor market recovery looks on track to forecasted S&P return target
continue, with positive feedback effects into credit growth,
consumer confidence, and business investment. CS Calculate the realized volatility of each resulting instance
economists forecast that the unemployment rate could fall Calculate the mean realized volatility in which the 6-month
to 5.4% as soon as 2Q this year. Meanwhile, the recent price path equals our S&P return target
fall in energy prices, if sustained, would deliver around an Baseline volatility = the mean of the sampled realized
$80bn tax cut for the household sector, and suppress volatilities
headline inflation to less than 1%.
Exhibit 6: Expected Volatility for 1st Half of 2015 (S&P to 2250) =13.1%
One important headwind, however, will be the Fed as it
gets set to embark on its first rate hike in almost a
decade. Its ability to successfully manage lift off will be
a key focus point for equity investors. While the market is
pricing for a first hike in September, CS economists
believe its most likely to be in June.
2015 Baseline Volatility @ 14.0%
Against this backdrop, our Global Equity Strategist,
Andrew Garthwaite, has a two-part S&P forecast (see
next page). He remains optimistic on equities for the first Source: Credit Suisse Equity Derivatives Strategy
half of 2015, with a half-year target of 2250, but sees Exhibit 7: Expected Volatility For 2nd Half of 2015 (S&P to 2200) = 14.9%
potential for a significant correction in the second half as
the Fed starts to hike rates. As a result, his end of year
target for the S&P is 2200 (see table below).

Accordingly, to develop our estimate for baseline volatility,

we analyze the volatility of the price paths (via a boot-
strapped Monte-Carlo) required for the S&P to reach
Garthwaites two S&P half-year targets. As shown in
Exhibit 6 and 7, the average required volatilities are 13%
and 15.6%, respectively. Taken together, we arrive at a
Source: Credit Suisse Equity Derivatives Strategy
full-year baseline volatility forecast of 14.4%.
Exhibit 8: Expected Volatility For Entire 2015 =14.0%
Exhibit 5: 2015 Baseline Volatility Forecast

S&P Level at Realized Vol

S&P Return
End of Period Forecast
1st Half 2015 2250 9.3% 13.1%
2nd Half 2015 2200 -2.2% 14.9%

Full Year 2200 6.9% 14.0%

Source: Credit Suisse Equity Derivatives Strategy

Source: Credit Suisse Equity Derivatives Strategy

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 EQUITY DERIVATIVES STRATEGY

1H S&P 500 Forecast 2H S&P 500 Forecast

We remain overweight equities for the first half We see a down market in second half of 2015
of 2015, with a mid-year target of 2,250 for the and hold a year-end target of 2,200 for the S&P
S&P 500 500
Valuations: US equities are not cheap in absolute Fed policy: We expect the Fed will raise rates around
terms, but asset allocation is a relative game and the middle of the year (most likely June). Historically,
equities look abnormally cheap against the other major the S&P has tended to peak relatively closely to the
asset classes. The US equity risk premium is 6.4% on point at which rates have risen and has seen a
consensus numbers versus the 4.4% our model correction after the Fed move. The drawdown in
suggests is warranted. Additionally, our simple P/E equities after the first Fed rate hike has ranged from
model still points to potential upside. 6% to 11%.
Liquidity: Central bank proactivity did not die in A return of labor bargaining power: Labor in the US
October when the Fed stopped purchases. If anything, finally appears to be achieving a degree of pricing
liquidity conditions will be more supportive in 2015 as power as both the wage component of the ECI and
Central bank balance sheets will expand by around average hourly earnings having started to turn up. This
13% compared to 5% in 2014. Liquidity tends to be represents a double challenge to earnings: it tends to
supportive for valuations. hit margins and the lower interest charge accounted
for 40% of the improvement in net margin (versus the
Positioning: The corporate sector has been the only
25 year average).
significant buyer of equities this year and we calculate
it still has enough fire power to buy $1.59trn of equity Exhibit 2: Equities tend to peak no earlier than four months
in the US, amounting to 10% of non-financial market before the first Fed rate hike (with 1977 the exception)
cap. Pension funds are still underweight US equities
and retail and institutional buying should shift to
equities as the Sharpe ratio of equities relative to
bonds closes.
Earnings: The most recent earnings season was
strong and margins outside the US are not extended.
We forecast 7.9% US EPS growth in 2015 and see
upside to consensus revenue forecasts of only 5.2%.

Exhibit 1: The gap between actual and warranted equity risk Source: Thomson Reuters, Credit Suisse research
premium remains abnormally high
Exhibit 3: Survey data suggests that wage growth will accelerate
in coming months

Source: Thomson Reuters, Credit Suisse research

Source: Thomson Reuters, Credit Suisse research

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 EQUITY DERIVATIVES STRATEGY

Potential Tail Catalysts (Kurtosis)

While we forecast baseline volatility at a benign 14%,
there are a number of macro catalysts that may
precipitate volatility shocks in the coming year. In the
following section, we explore in detail the top three macro
catalysts that we believe could have a significant impact
on equity volatility over the next 12 months:

Potential Catalysts That Could Drive VIX Higher

A Russian Default: The dramatic fall in oil prices in the
second half of 2014 has led to a collapse of the
Russian economy. The key question facing investors
is if that will in turn lead to a debt default. We explore
the parallels to the 1998 crisis and estimate that if a
default were to happen, it could drive the VIX ~10 vol
pts higher.

Euro Breakup: 2015 starts with a Greek election and

ends with a Spanish election. With the incredible rise
in popularity of Eurosceptic parties in recent years, we
believe investors may be underpricing the risk of a
euro breakup, which could send the VIX to as high as
40%.

Interest Rate-Induced Volatility Shock: Bond market

volatility has been the biggest driver of the VIX for the
past two years. We believe this could again be the
case in 2015 as the Fed prepares to hike rates.
Worryingly, the rate market looks more susceptible to
a big shock as dealers cut back risk and quote depth
shrinks.

Exhibit 9: 2015 Steady-State VIX Forecast of 18%

Source: Credit Suisse Equity Derivatives Strategy

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 EQUITY DERIVATIVES STRATEGY

1. Russias Groundhog Day: Is it 1998 Again? aggressively hike interest rates, now at a growth-killing
17%. So Russian companies will default either because
A Crude Awakening their rubles wont be worth enough to pay back their debt,
or because they wont have enough rubles as the
Surprise! It turns out that having your entire economy recession takes away their customers.
based on oil may not be such a good idea. All it takes is
Exhibit 2: The Russian Ruble vs. Oil: Both down ~50% From Peak
an unexpectedly large correction in oil prices to send your
economy into freefall. Unfortunately, Russia is finding this
105
out the hard way. Brent Oil Russian Ruble
95

Performance (Indexed at 100)

The oil and gas sector currently make up 20% of Russias
GDP, 52% of its federal budget revenues, and almost 85

70% of total exports (see Exhibit 1). So it should come as 75

no surprise that with Brent oil prices down 50% from their
June peak, Russia is heading into a deep recession. 65
Already, its Finance Minister is projecting that the Russian central bank hikes
55
economy could shrink by 4% in 2015 if oil prices stay at rates 650bps to 17%
$60/bbl (Brent oil is currently at $56/bbl). The latest data 45
show that GDP has already started to contract, down Jun-14 Jul-14 Aug-14 Sep-14 Oct-14 Nov-14 Dec-14
Source: Credit Suisse Equity Derivatives Strategy
0.5% yoy in November.
In the end, whos on the hook for all the loans Russian
Exhibit 1: Oil & Gas Sales Account for 68% of Russias Exports
businesses took out? Russian banks, of course. Their
balance sheets are full of dollar loans that wont get
repaid and ruble assets that are now worth only a fraction
of their original value. This is why the Russian credit
market has seized up, with the overnight lending rate
skyrocketing to a high of 27% - exceeding even the
extremes reached during the 2008 Financial Crisis (see
Exhibit 3). Already, one mid-tier bank has collapsed,
forcing authorities to step in with a $530 million bailout
that then quickly ballooned to almost $2bn in a matter of
days. Now, Russias Finance Minister is warning that two
Source: US Energy Information Administration, Russia Federal Customs Service of the countrys biggest banks Gazprombank and VTB
may require $6bn in recapitalization as well.
The fall in oil prices has also spurred a currency crisis,
with the Russian ruble falling almost in lockstep with Brent
So what started initially as a currency crisis has now
(see Exhibit 2). In a surprise move last month, Russias turned into full blown economic and credit crises as well.
central bank hiked rates an impressive 650bps to 17% in How bad could things get?
an attempt to stem the tide of currency depreciation.
Unfortunately, investors were less than impressed after Exhibit 3: Russia is Facing a Bigger Credit Crunch Than 2008
a brief rally, the ruble resumed its decline. Credit Suisse
FX Strategy team is now projecting the ruble basket 30
(55% USDRUB and 45% EURRUB) to reach 80 in three Moscow Prime O/N Rate

months, representing a 27% further depreciation from 25

current spot of 63. 20

Stuck in a Catch-22 15

The reason for continued pessimism is that Russia has no 10

good options right now. It cant afford to let the ruble fall
5
because Russian companies took out a lot of dollar debt.
Total private sector external debt stands at over $650bn, 0
of which over $100bn needs to be rolled over in 2015. Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14
But in order to prop up its currency, Russia is forced to Source: Credit Suisse Equity Derivatives Strategy

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 EQUITY DERIVATIVES STRATEGY

The Bear Case: a Russian Default la 1998? Timeline of 1998 Russian Debt Crisis

Theres been a lot of comparison between the woes

Russia is facing today vs. the crisis it endured in 1998
(see grey box). Optimists will point to one important
differentiating factor: Russia has a much bigger war chest
to fight with today. FX reserves totaled just $20bn in
1998 vs. an impressive $400bn now. However, on closer
examination, that total is misleading for several reasons.
First, liquid reserves may only be about half that amount,
but more importantly, Russia is burning through its
reserves at a rapid pace. Total reserves are down 20%
this year and the pace has only intensified. This is
because there are multiple things Russia needs to pay for
with its dollar reserves.

Exhibit 4: What Russia Needs to Use Its Dollar Reserves For

Source: Credit Suisse Equity Derivatives Strategy

Source: Credit Suisse Equity Derivatives Strategy Impact on Equity Volatility

Is $400bn (with only half liquid) enough to: If Russia does default, we can look to 1998 as a guideline
for how the VIX will react. The crisis really came to a head
- Fund the budget deficit: projected to be ~3% of GDP in May 1998, when the central bank hiked rates to 150%
if oil stays at $60/bbl next year in an attempt to defend the ruble. The Russian stock
market collapsed with volatility surging from 20 to a high
- Lend to corporates: Russian companies need to roll of 120 in just a month. Surprisingly though, US markets
over $100bn of loans in 2015 barely reacted, with the VIX trading in a stable range
- Recapitalize banks: Already committed $8bn to averaging just 21 (see Exhibit 5). Volatility remained low
rescuing three banks; more lenders likely to go under until just three weeks before Russia officially defaulted.

- Defend the ruble: ruble has tumbled in almost Exhibit 5: The VIX in the Months Before the Russian Default
lockstep with oil
140
Russia Micex Index 1M Vol VIX Index
At this point, its a race against time. Can Russia keep its 120
economy afloat long enough for oil prices to rebound? If
not, then it will need to do one of three things: 1) impose 100
Russia hikes rates to
hard capital controls, 2) pull out of Ukraine in order to
Volatility (%)

150%, teeters toward

80
access international capital, or 3) default. The first option default

will be politically unpopular while the second would be an 60

...But the VIX does
embarrassment for Putin and hence unlikely. From 40 not react at all
Russias perspective, default may not be the worst option
20
as its already shut out from international credit markets
due to sanctions. 0
4/1/1998 5/1/1998 6/1/1998 7/1/1998 8/1/1998

Source: Credit Suisse Equity Derivatives Strategy

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 EQUITY DERIVATIVES STRATEGY

It wasnt until the beginning of August that US markets Exhibit 7: European Banks Exposure to Russia (% of GDP)
realized default was looming on the horizon. Russia was
quickly running out of reserves trying to defend its
currency. The VIX surged 10 vol pts to 34 by the eve of
ruble devaluation and quickly escalated to a high of 45
after Russia defaulted just two days later (see Exhibit 6).
The key takeaway here is that US volatility may be slow to
react and US investors have shown in the past a
propensity to severely underprice the risk of a Russian
default.

Exhibit 6: Russian vs. US Equity Volatility During 1998 Default

Source: Credit Suisse Research

250 50
Russia Micex Index 1M Vol VIX Index (Right Axis)
45 Top Russia Hedge
200
LTCM Bailout 40
We recommend buying a far OTM put option in RSX
Micex Vol (1M)

35
150
(Russia ETF) as a tail hedge against default. Even though
VIX Index
30
100 25
RSX implied volatility has surged higher in recent weeks,
20
its still far below its 2008 peak. This stands in sharp
50
Russia officially defaults
on Aug 19, 1998
15 contrast to other asset classes (e.g. credit and FX) where
0 10 implied vols have far exceeded their 2008 highs,
8/1/1998 9/1/1998 10/1/1998 11/1/1998 12/1/1998
suggesting equity vol may be underpriced. See pg 43 for
Source: Credit Suisse Equity Derivatives Strategy
details.
Another takeaway is that volatility may remain elevated for ***The risk of buying a put is limited to the premium paid.
a while as the full scope of repercussions materializes. In
1998, the VIX stayed in a range of 35-45 for over a
month after it became apparent just how leveraged the
US financial sector was to Russia. Vol peaked as LTCM
went under, requiring the Fed to orchestrate a $3.6bn
bailout and three rate cuts to stop the contagion.

This time, it wont be the US financial sector thats

leveraged to Russia, but rather, the European banks. A
Russian default could jeopardize the health of key financial
institutions. In particular, Austrian and French banks hold
a significant amount of Russian corporate debt on their
balance sheets (Exhibit 7). Hence, Eurostoxx volatility,
especially for the financial sector, could remain elevated
for a sustained period of time even after a default.

Accordingly, with Europes increased exposure to Russia

versus 1998, we believe that the V2X/VIX spread could
jump to its highest sustainable level so far (20 volatility
points), pushing the V2X towards the 60 handle: in-line
with levels reached in 2002, but still below levels reached
at the peak of the Equity market sell-off in 2008.

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 EQUITY DERIVATIVES STRATEGY

2. Europe Political Contagion is the Key this dangerous game of chicken, theres a higher
probability they will try to call each others bluff.
Here we go again. As we begin 2015, yet another
Exhibit 2: Volatility Spillover Btw Sovereign Credit & Equities
chapter in the European sovereign debt saga is unfolding.
This time, its spurred by the collapse of the Greek
government after it failed to elect a president. Snap
elections are now scheduled for January 25th. The bad
news for investors is that the frontrunner appears to be
the far-left Syriza party, which is running on a promise to
renegotiate Greeces austerity program. Germany,
predictably, has adopted a hard line response, with its
finance minister warning that there is no alternative to
austerity. At stake, even if not explicitly stated, is
Greeces continued membership in the EU.

Greek Election: An Underpriced Risk Source: Credit Suisse Equity Derivatives Strategy

A High Stakes Game of Chicken

If all this sounds familiar its because it is. The Greek
elections in 2012 were fought over these exact same Unlike in 2012, Greece can now afford to leave the euro
issues. Even though the mainstream coalition managed to because it has swung from running a primary deficit to a
eke out a win back then, just the threat of a Greek exit surplus. Back then, defaulting would have meant more,
from the euro managed to send US equity volatility rather than less, austerity as it would have had to
surging 10 pts higher to 26% that year (see Exhibit 1). immediately balance its budget. Now, with a primary
Exhibit 1: Greek Elections Were the Biggest Drivers of VIX in 2012
surplus of 3% of GDP, leaving the euro becomes at least
a plausible threat.
28 1

26 Greek Elections (5/6; 6/17)

0.9 Germany, back in 2012, couldnt afford to let Greece
24
VIX
0.8
leave the euro because of contagion fears. That was
during the height of the sovereign debt crisis and panic
0.7
22
0.6
over a Greek exit had already sent Italian and Spanish
VIX (%)

20
0.5
18
0.4
bond yields north of 7%. Today, however, both are
16
0.3 trading at all-time lows of sub-2%. Not even the latest
14 0.2 bout of political drama in Greece was enough to catalyze
12 0.1 those bond yields up (see Exhibit 3 for divergence in
10
Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12
0
Greek vs. Italian/Spanish 10-year rates).
Source: Credit Suisse Equity Derivatives Strategy
Exhibit 3: The End of Contagion? Bond Yields Diverge

This time, however, markets seem to be taking the Greek 4.5 10

political risk in stride. As we approach the upcoming Jan 4 9

25th election, volatility spillover between European 8

3.5
sovereign credit and equities is down to a benign 48%,
Bond Yields (%)

7
compared to a high of 80% reached during the 2012 3
6
Greek election (see Exhibit 2). It certainly could be that 2.5
with the ECBs whatever it takes pledge (and potentially 5
2
sovereign QE), the fallout from a Greek exit will be Italy 10Y (Left Axis) 4

contained this time. 1.5

Spain 10Y (Left)
3
Greece 10Y (Right)
1 2
We think investors may be underpricing both the Jan-14 Mar-14 May-14 Jul-14 Sep-14 Nov-14 Jan-15
probability and the impact of a potential Greek exit. The Source: Credit Suisse Equity Derivatives Strategy
reason theres a greater likelihood of a Grexit now
So now, more than ever, Germany may be lulled into
versus 2012 is that both Germany and Greece think they
thinking it could let Greece leave without breaking up the
have a stronger hand this time around. And that means in
rest of the euro, while Greece for the first time, can
legitimately threaten to leave. Neither wants to break up,
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 EQUITY DERIVATIVES STRATEGY

but neither of them is so averse to the possibility that they 3. Ragin Contagion: Rising Rates Pose a Risk
would do anything to avoid it.
Interest rate risk has consistently been the biggest driver
The Rise of the Eurosceptics of equity volatility in recent years. In 2013, Bernankes
If Greece were to leave the euro, the biggest risk wont surprise taper comments in May sent both rate and equity
be financial contagion, but rather political contagion. Even volatility surging higher. The CS Interest Rate Volatility
if the ECB were able to step in and support the other Index almost tripled in the aftermath while the VIX gained
periphery bonds, the central risk is that a Greek exit will over 8 vol pts. In 2014, concerns over global growth
bolster anti-EU sentiment in the rest of the continent. caused yields to collapse in October and set off the
biggest increase in equity vol in over 3 years, with the VIX
Already, anti-austerity Eurosceptic parties have been jumping to an intra-day high of 31%.
rapidly gaining in popularity all across Europe. Together,
Exhibit 1: Volatility Contagion Btw Interest Rates and Equities
they won an unprecedented 25% of the seats in the
2014 European Parliament election. In Spain, a party that 80%
was just started less than a year ago is now their most Taper Talk
popular political party (see Exhibit 4). Podemos, like Syriza 70%

in Greece, has promised to boost social spending if it

60%
were to win power. That could be a reality as early as this

Volatility Spillover
year when Spain holds general elections (no firm date is 50%
Oct'14 Sell-off

set, but most likely the election will be in Oct-Nov). A win

by a Eurosceptic party in Spain would seriously threaten 40%

the future of the common currency. 30%

SPX vs. 10Y Treasury Yield (1M)
Exhibit 4: Podemos has Surged Ahead in Spanish Election Polls 20%
Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 Jul-14 Oct-14
Source: Credit Suisse Equity Derivatives Strategy

Equity Sensitivity to Rate Volatility at a High

Both times, the panic in the rates market had a big

spillover impact on equities, with volatility contagion
between the two assets reaching highs of almost 70%
(see Exhibit 1). This means that when rate vol increased,
70% of the time the VIX also increased. While the
Source: Wikipedia measure has fallen somewhat in recent weeks, it still
remains elevated at ~60%, signaling heightened
Impact on Equity Volatility sensitivity of equity vol to interest rate movements.

We believe equity volatility will rise heading into the Greek Exhibit 2: Fed Funds Futures are Pricing for a September Hike
election on Jan 25th. A Syriza win could lead to as much
as a 10 vol pt gain depending on how far the ensuing 0.8
1-Year Ago
game of chicken goes between Germany and Greece. In 0.7 Current
the true tail scenario where Greece leaves the euro, 0.6 First Fully Priced Hike (+25bps)
political contagion risks would rise dramatically as 0.5
investors wonder who will be the next domino to fall. In
Yield (%)

0.4
that case, we think equity volatility could return to the
0.3
highs we saw in 2011 when V2X traded over 50% and
VIX over 40%. 0.2

0.1

0
Top Europe Hedge Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
2015 Fed Fund Futures
We recommend buying a put spread on FXE (Euro Source: Credit Suisse Equity Derivatives Strategy
Currency ETF) as a tail hedge for a breakup scenario.
See pg 43. ***The risk is limited to the premium paid.

11
 EQUITY DERIVATIVES STRATEGY

As we look ahead to 2015, interest rate risk stands out This was especially apparent during the taper tantrum in
once again as a potential catalyst for equities. This is 2013, when quote depth diminished substantially (see
especially true as the Fed prepares to embark on its first Exhibit 5), meaning it took significantly less volume to
rate hike in almost a decade. Currently, the rate market is move the market. Its also worth noting that the
pricing for a September hike (see Exhibit 2), but given the diminished depth was most apparent on the bid side
recent acceleration in US growth, the risk is that an dealers didnt want to buy. Liquidity dried up fastest on
increase could come earlier. Indeed, CS economists are that side just as investors were all trying to sell bonds (as
calling for a first hike in June. rates were rising).

Exhibit 3: Option Investors are Positioning for Lower Yields Exhibit 5: The One-Tick-Wide Bid Size Fell Drastically During Taper

3
5Y Treasury Skew (Put-Call)
2.5

1.5
bp/daily

0.5

-0.5 FV 2M 6-Strk Skew (Put-Call)

-1
Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 Jul-14 Oct-14 Jan-15
Source: Credit Suisse Equity Derivatives Strategy
Source: Credit Suisse Research

If that were to happen, it could cause significant disruption

Unfortunately, there is a nasty self-fulfilling dynamic at
as the market is clearly not positioned for it. You can see
work here, whereby an uptick in volatility leads to
this in the options space, where investors have been
shallower markets, which in turn leads to even higher
bidding up the price of calls relative to puts on Treasury
volatility. As a result, there is more likelihood for outsized
bonds (i.e. expecting lower yields). As a result, skew on
moves in the bond market. Investors got a taste of it
the 5-year note has fallen to near a 1-year low (see
during the October sell-off last year when a disappointing
Exhibit 3).
retail sales release in the US led to a 7-standard deviation
The Rates Market Has Become More Fragile tail event in the Treasury market. Within the span of an
hour, the 10-year yield dropped an incredible 30bps as
In addition, our Interest Rate Strategy team highlights that liquidity completely dried up. To put that in context, the
regulatory changes have permanently impaired FICC move is equivalent to a 10% intraday drop for the S&P.
dealer balance sheet elasticity. Lower risk taking capacity
means dealers are less able to step in and act as an Therefore, a big risk for equity investors going forward is
intermediating buffer during times of market stress. These that we get another bout of extreme volatility in the rates
constraints have manifested in wider and shallower market which then spills over into equities. This scenario
markets in periods of risk-off and high volatility (see could be precipitated by an earlier than expected Fed rate
Exhibit 4). hike that catalyzes an abrupt move higher in yields. In this
case, we expect the VIX to behave similar to the taper
Exhibit 4: Quote Depth Vanishes as Volatility Picks Up tantrum of 2013 and the October sell off last year, where
it increased by 8-10 pts in response to rising interest rate
volatility.

Top Interest Rate Hedge

For equity investors looking to hedge against a selloff in
equities caused by a move higher in rates, we recommend
buying an ATM put on the S&P contingent upon the 5Y
swap rate rising to above 3% by expiry. See pg 44.
***The risk of buying a contingent put is limited to the premium paid.
Source: Credit Suisse Research

12
 EQUITY DERIVATIVES STRATEGY

Term Structure Outlook

For much of the last decade, the 10-year S&P term Exhibit 1: Expected Trading Desks Aggregate Vega vs SX5E Level
structure had been clearly segmented into 3 niches,
defined by the investor groups that demanded derivatives
within their specific maturity band. Accordingly, institutions
and hedge funds who invested based upon headline news
and the latest revisions in economic data controlled the 0
to 1 year space. Structured notes investors who
expressed slightly longer views on equities as a strategic
asset commanded the 1 to 5 year tenors. Finally,
insurance companies who, in response to regulations,
were required to hedge variable annuities liabilities
measured in generational time scales gravitated towards
the 5 to 10 year maturities. Source: Credit Suisse Equity Derivatives Strategy

Recent developments have now created a new paradigm. Exhibit 2: Suppresses Back End of SX5E Volatility Term Structure
While active managers and hedge funds still comprise the
bulk of demand for short-dated (sub one-year) options,
insurance traders have moved away from the far end of
the term structure and are now becoming a significant
and active participant in the 0 to 2 year space. Although
their flight down the term structure briefly left a void in the
6 to 10 year space that resulted in a sharp decline in
long-dated liquidity, that space is now being filled by
structured notes investors who as we shall discuss later,
have not only stepped into the vacuum but have begun to Source: Credit Suisse Equity Derivatives Strategy
widen the term structure out to 15-years.
Exhibit 3: While Having Minimal Impact on the S&P Term Structure
The driver of this process has been the spectacular
development of short-volatility instruments wrapped into
note or certificate format.1 These yield-generating
structures are by nature unhedged by their end investors
and have added a large short-volatility overhang on the
term structure.
Exotic trading desks have now become the largest natural
buyers of long-term volatility, and trading along those
positions has become the main driver of volatility dynamics
in the middle portion of the term structure particularly for
the most popular underlying, the Eurostoxx-50. As shown Source: Credit Suisse Equity Derivatives Strategy
in Exhibit 1, we calculate that $6M of SX5E vega needs
to be sold on the market by trading desks for every 1% Exhibit 4: Increasing Likelihood of SX5E Vol Backwardation
down move in the SX5E. Using this rule of thumb, we
therefore infer that it is no less than $66M vega that
would have been dumped on the market when the SX5E
fell 11% in the first half of October, and $50M bought
back when the SX5E rebounded by 8%. As shown in
Exhibits 2 and 3, this has created a suppressive effect on
the back end of the Eurostoxx-50 implied term structure
relative to the S&P, increasing the likelihood of a future
SX5E backwardation.

1
This topic was discussed in depth in our report The Mighty European
Autocall Market (Click here for full report)
Source: Credit Suisse Equity Derivatives Strategy

13
 EQUITY DERIVATIVES STRATEGY

Structural Skew Outlook

Exhibit 1: Oct 9-13 Pullback: -2.07%, -1.15%, -1.65%
Skew Dynamics in 2015
When discussing the dynamics of VIX levels with respect
to the underlying S&P skew, volatility professionals often
refer to one of three dynamics:
a sticky-strike behavior whereupon at-the-money
implied volatility slides up and down a static skew
depending upon spot S&P,
a sticky-delta behavior whereupon the entire skew
surface shifts in parallel
Source: Bloomberg
and a change in the gradient (i.e., flattening or
steepening) of the skew Exhibit 2: S&P Put Strikes Reined in 200pts on 1st Day of Pullback
Volatility traders typically expect one of these three effects
to dominate depending upon the magnitude of the spot
underlying whereupon:
a small change in spot changes vol by sticky-strike
a medium move in spot changes the skew gradient
a large (usually downward) move in spot cause the
skew to move in parallel
Strike Breadth and Skew
Source: Credit Suisse Equity Derivatives Strategy
Less often discussed is the actual range of strikes used in
the calculation of VIX. The likely reason is that the Exhibit 3: But Overcompensates as Pullback Continues
contribution of strike range changes often coincides with
and is dominated by one of the other behaviors. As such
the amount of shock we expect from the VIX in the
event of say, a 2% market pullback, is typically the
aggregation of new bids for downside S&P put options
strikes and a sizeable parallel upshift of the entire skew.
Throughout the volatile fourth quarter of last year,
however, we observed a completely new dynamic.
Specifically, upon an initial sharp market pullback, the
range of put-side options reined in (suggesting a Source: Credit Suisse Equity Derivatives Strategy
monetizing of put options), rather than expanded out,
significantly. This in turn caused the VIX to under-react
Exhibit 4: VIX Attribution Comparison Oct 7 vs Oct 15
according to trader expectations. However, in the cases
where the market continued to pull back, the range of VIX Attribution
downside put options which were activated significantly 7-Oct 15-Oct
exceeded the norm. This in turn caused the VIX to over- S&P Chg (%) -1.51% -0.81%
react. This under-compensating/ over-compensating VIX Chg (Pts) 1.74 3.46
dynamic in turn caused highly volatility fluctuations in the
VIX which manifested itself in vol of vol. Expected Chg 2.13 1.28
Parallel Shift 0 1.43
Roll -0.01 -0.03
Marginal Calls -0.04 0
Marginal Puts -0.34 0.78
Source: Credit Suisse Equity Derivatives Strategy

14
 EQUITY DERIVATIVES STRATEGY

Long-Dated SX5E/S&P Skew Dislocation Skew, Convexity, and Vol of Vol

Different macro backdrops are creating opposite reactions Of the three primary aspects of the volatility surface, skew
across the Atlantic, with a resulting impact on longer is the one that is most inconsistently defined. Even within
dated skew. the same firm, the precise definition of skew may vary
from trader to trader and can refer to one of the following:
While the typical US investor reacted to record-low
1) a volatility differential by moneyness (e.g.: 90%-110%
interest rates by investing in stocks, the typical European
strikes); 2) a volatility ratio (e.g.: 90%/110%); or 3) a
investor has stayed clear of a direct investment in risky
volatility differential by delta (e.g.: 25 delta put 25 delta
assets. Europe starts 2015 with record low Equity
call).
allocation in insurers and pension funds, and generally
little interest for downside protection due to the poor The common feature among these definitions is that they
performance of hedges over the last few years. Instead, all involve taking the difference of 2 points along the skew
they have piled into autocalleables which as described in surface. Although in relatively stable volatility
the previous section, produces a large dVega/dSpot environments (i.e., low to moderate vol-of-vol and a VIX
overhang. This position creates extreme effects on the level close to its historical average of 20), relative
pricing of SX5E skew, as expectation of a sell-off in differences in the determination of richness or cheapness
volatility in the event of market duress artificially of skew between the varying definitions is negligible, they
depresses the pricing of implied vol for the lower strikes. are all based upon a common assumption: that equity
As shown on Exhibit 5, the SX5E 3Y skew has now index skew is downward sloping. 2
reached all-time lows.
Recent developments regarding the likelihood of an
By comparison, the S&P index has not been an upside tail-event and the current low volatility regime
underlying of choice for yield products, because US long- may challenge this assumption going forward. Specifically:
only investors who were overweight the S&P index have 1) the decisive market rally in 2013, a 3-standard
so far benefited from dividend yield of close to 2%, and deviation event with the VIX averaging 14
spectacular capital gains since 2011. Moreover, longer
2) lack of interest in selling calls given the low vol
dated S&P skew continues to be marginally pushed up by
levels and opportunity cost of missing a rally
residual insurance products such as variable annuities.
Thus, the rift between longer-dated (3+yr) volatility skews As a result, skew has become increasingly convex (more
in the US and Europe is now reaching dislocation levels. bowed), especially in recent months.

Exhibit 4: Leading to Unusually High Vol-of-Vol

Exhibit 5: SX5E vs S&P 3Y 80/120% Volatility Spread

9%

8%

7%

6%

5%

4%

3%

2% SX5E Skew SPX Skew

1%

0%
1998 2000 2002 2004 2006 2008 2010 2012 2014
Source: Credit Suisse Equity Derivatives Strategy Source: Credit Suisse Equity Derivatives Strategy

2
Recall that downward sloping equity index skew has held sway since the
Crash of 87 to compensate for the empiricism that 1) large 3+ standard
deviation market moves are usually associated with market declines rather
than increases 2) portfolio managers are willing to pay a premium for
downside protection 3) investors tend to harvest yield by selling calls.

15
 EQUITY DERIVATIVES STRATEGY

Quantifying Skew Convexity

We believe the effects of skew convexity will be especially While admitting that the process of translating structural
acute in 2015. Recall that in our framework, skew demand to volatility requires a combination of art and
includes the probability of 2-standard deviation moves science, we attempt to do so by surveying each of our
(daily returns), whereas 3+ standard deviation moves major client groups in the following sections: hedge funds,
manifest themselves within the tails (kurtosis). We asset managers, insurance funds, structured retail, and
hypothesize that if the market has built-in expectations for pension funds. We conclude by extrapolating implications
shocks arising from the previously mentioned macro of emerging derivatives trends.
catalysts, shocks that would normally precipitate a fat- Our survey reveals that as volatility is likely to remain low
tailed market move in excess of 3-standard deviations in 2015, institutions and fundamental long-short hedge
and would now have a more muted impact upon the funds will likely rein in call-overwriting and other skew-
market, resulting in smaller, 2-standard deviation moves suppressing yield-enhancement strategies. Furthermore,
instead. We therefore expect volatility markets will we expect to see an increase in option use to express
experience higher rates of change in skew convexity (high directional views. These activities should reinforce the
vol of skew) than in years past. effects of increased skew convexity discussed earlier,
In these situations, measures of skew that reply upon resulting in increased skew beta sensitivity relative to
simple put-call volatility difference calculations can differ spot vol.
vastly from measures that take into account its curvature. .
If this effect persists in 2015 we suggest supplementing
traditional measure of skew with a probability distilled from
the implied distribution which represents likelihood of
decline below a certain level.

Exhibit 8: Estimates of Volatility Contribution by Client Type

Structural/ Transient Skew Decomposition
Structured
In order to discuss the time series of skew across Retail, 10%

different (high vs. low) volatility regimes, we reference a Pensions, 5%

definition of skew that is relatively insensitive to spot Vol Funds,

volatility and takes into account the curvature of skew. Insurance,
30%

Specifically, we define skew using a modified form of the 15%

variance swap calculation in which skew refers to the

premium of weighted volatilities across a range of strikes Long Only/HF,
over at-the-money implied volatility. 30%

In this framework, the time series of skew is subdivided

into two components: 1) a structural component
representing the volatility premium attributable to implied Source: Credit Suisse Equity Derivatives Trading

volatility through investors desire to hedge or generate

yield under normal market conditions and 2) a transient
component of skew referring to the volatility attributable to
implied volatility via the desire to hedge in times of market
duress (see Exhibit 2).
Exhibit 7: Structural Skew ~ 1.0% in 2014

Source: Credit Suisse Equity Derivatives Strategy

16
 EQUITY DERIVATIVES STRATEGY

Institutional/ Fundamental Long-Shorts Exhibit 1: Alpha Availability Declined to 20-Year Lows

General Outlook
In the wake of a very difficult year for active investors,
institutional and fundamental long-short hedge fund
derivatives flow in 2014 reflected the pursuit of alpha. As
shown in Exhibit 1, with inter-stock correlations declining
to record lows, performance differentiation was predicated
upon stock fundamentals. Consequently, active managers
pushed volatility considerations onto the back burner and
effectively created a vertically integrated market at the
single stock level whereupon value investors overwrote
calls / call-spreads on companies with rich multiples Source: Credit Suisse Equity Derivatives
which in turn were purchased by speculative growth
managers as a levered delta play. Exhibit 2: Average Stock Volatilities Decline to Historic Lows

2015 Derivatives Trading Implications

Although stock dispersion has declined, sector dispersion
still remains high. If the elevated level of vol-of-vol
becomes more recurrent, particularly as we head into the
second half of the year, we anticipate major changes with
respect to how institutions employ derivatives:
Yield Generation: Conditions in the US are aligning
towards what one of our senior marketers terms an
overwriters paradise3. Although the average implied
volatility of single stocks hovers near 15-year lows
(Exhibit 2), short-dated realized volatility levels at the Source: Credit Suisse Equity Derivatives Strategy, Bloomberg
stock level have continued to systematically
underperform by 1 to 2 vol pts. As we head into a
Exhibit 3: Stock Dispersion Has Declined, Sector Dispersion High
capped H2, we expect overwriters to access higher
volatilities by lengthening the duration of overwrites
from 1-2 months to 3-6 months.
Directional Positioning: Institutions generally expect a
strong H1, an outperformance of Europe versus the
US4, and a rebound in banks, oils, and miners but
few are actually positioned for this. However, given
the volatility contagion overhangs, we expect tactical
positioning trades to be expressed via strategies with
lower net vega mark to market exposure such as risk
reversals or call/put spreads on the Eurostoxx, or
sectors such as banks, materials, or oil producers5.
Source: Credit Suisse Equity Derivatives Strategy
Hedging: In light of the difficulty hedgers have had in
monetizing hedges amidst the market whipsaws in
2014, there remains a general disaffection for hedging
trades that will likely continue in the absence of a
major tail event.
3
Jason Halio, Managing Director, Credit Suisse
4
Europe has seen positive inflows from US asset managers during the first
3 quarters of 2014 although this trend reversed temporarily in Q4.
Levered delta should, however, trade in size in the event of a positive QE
announcement.
5
Banks (XLF, SX7E), materials (XLB, SXPP), oil producers (XLE, SXEP).
We saw a similar reaction on Nikkei back in 2013 when Bank of Japan
announced their own QE program.
17
 EQUITY DERIVATIVES STRATEGY

Volatility Hedge Funds term structure) have often involved a short S&P vega leg.
Consequently, vol hedge funds as a community are
General Outlook
starting the year having reached their risk limits on an
Trading vol-carry strategies last year was a bit like playing increasingly crowded short S&P variance trade.
whack-a-mole. While geopolitical tensions and global
growth concerns provided a number of occasions to sell Secondly, the abovementioned delay in reaction time has
volatility, the opportunities were generally short-lived. As been due to in part to the conditioning of short vol traders
a result, traders who required more than a day or two to to trading in a low volatility regime. Thus they have been
digest news of a volatility spike often found that the accustomed to think about trade entry/exit points in terms
window of opportunity had lapsed. In the two instances in of absolutes. Given the extreme regime changes weve
which the markets experienced a sustained level of seen and the resultant high vol of vol at the end of the
volatility in excess of a week (in mid-Oct and the year, successful vol traders will have to be much more
beginning of Dec), the uncertainty of a bimodal shock, reactive to relative changes presented by a higher vol of
and correspondingly vol-of-vol, became so high that many vol regime.
short volatility traders actually took money off the table
rather than expose themselves to the possibility of a Exhibit 2: High Vol-of-Vol Uncertainty Tempered Short Vol Bets
catastrophic failure. Accordingly, as shown in Exhibit 1,
volatility carry funds which constitute the bulk of the
performance represented by the HFRX Volatility Index
(HFRXVOL) tended to experience a relatively steady
upward drift in performance during most of the year but
often stagnated upon volatility spikes.
Exhibit 1: Volatility Hedge Fund Performance vs. VIX Range

Source: Credit Suisse Equity Derivatives Strategy

Finally, in recent years, the volatility HF funds have biased

towards (systematic) short variance strategies. While
profitable during the low volatility regime experienced over
recent years, this often leads many vol hedge funds to
Source: Credit Suisse Equity Derivatives Strategy, Bloomberg
underperform when volatility spikes. Viscerally, however,
many investors view the investment mandate for vol
By contrast, while a low volatility regime is obviously hedge funds as outperforming during volatility shocks. As
beneficial for volatility carry, low volatility levels prove to be a result, we believe hedge funds will gravitate more
detrimental to the comparatively longer tenored (1+ years) towards relative value, which have long-vol biased
trades favored by volatility long-short funds as it 1) exposures and thus tend to thrive in a higher vol-of-vol
magnifies the impact of transaction costs and 2) limits the environment, as well as engage in relative value trades
potential for a quick mark-to-market gain on the longer such as dispersion or variance spreads6. A continuation of
tenored trades. As a result, vol L-S performance which is the high vol of vol environment experienced last year will
represented by the Newedge (NEIXVTI) index tended to likely lead banks to offload systematically profitable but
be negatively correlated with vol carry funds, displaying a balance sheet intensive risk from their books. We will
steady downward performance drift throughout 2014 likely see vol hedge funds stepping in to buy capped var
punctuated by periods of outperformance during volatility and provide liquidity for systematic index strategies.
spikes.
2015 Derivatives Trading Implications
Going into 2015, short vega strategies face a number of 6
2014 trades have been consistent with this trend, including dispersion
changes. The most popular strategies amongst volatility trades on SX5E, S&P, FTSE or even SMI indices, and variance spread
trades mostly going long SX5E or Asian indices versus going short S&P
hedge funds (selling capped variance outright, relative (see Variance Spreads outlook page 40).
value bet vs another index, a dispersion trade, or a short
18
 EQUITY DERIVATIVES STRATEGY

Insurance Companies vega among insurers and the concentration of their

activity towards the sub 2-year portion of the term
General Outlook structure, we believe that long end (5+ year maturity) of
Insurance companies, once purely synonymous with the volatility surface will be dictated by the demand for
buyers of long-dated volatility, have redefined themselves structured retail products. However, if the markets pull
as one of the most sophisticated users of not only volatility back in excess of 20%, we should see a renewed interest
instruments but of volatility doctrine. Case in point, until in volatility in the very long term (>5 years) on behalf of
last year, insurance companies for the most part still European insurers who may look to reallocate back into
focused on extrinsic solutions to their contingent claims equities.
risk. Accordingly, risk discussions prior to last year Exhibit 1: Volatility Targeting ~33% of Risk Controlled AUM
centered on ways to cheapen or offset the cost of a
classical hedge (e.g., buying puts). The newly
developing paradigm, however, has been to alter the
intrinsic vega profile of the contingent claim itself via
techniques such volatility targeting and dynamic asset
allocation. In a 2014 study, Milliman estimates that
~$70B of variable annuity AUM is currently managed
using volatility targeting. Although this may seem small
relative to the size of the industrys $2T variable
exposures, the more telling statistic is that nearly 95% of
the $140B in new VA sales incorporates a volatility
control feature.
Source:Milliman
With embedded risk controls curtailing the need for
downside protection, the bulk of the demand for volatility Exhibit 2: Legacy (Pre-Crisis) VAs are 20% to 60% OTM
arises from the ~$1.1T in legacy (pre-Crisis) positions.
The materiality of the legacy positions is in turn a function
of market performance and regulatory mandates across
geographical domiciles:

US: From the perspective of volatility demand, US legacy

VA exposures are largely immaterial. With regulatory
hedges completely established following the Crisis, the
continued rally of the US equity markets has pushed
legacy GMxB exposures 20% to 60% out the money.
Europe: Due to the underperformance of the European
equity markets relative to pre-Crisis levels, European VA Source: Credit Suisse Equity Derivatives Strategy
exposure has the potential to be more sensitive to volatility
levels as a greater percentage of legacy GMxB positions
Exhibit 3: European Insurers Actively Rebuilding Solvency Ratios
are in the money. Moreover, European insurance
companies have to rebuild their solvency ratio ahead of
the implementation of the Solvency II directive in 2016.
However, rather than accessing the volatility markets,
European insurers have instead opted to trim their equity
allocations to record lows. 7

2015 Derivatives Trading Implications

We estimate that all told, insurers will trade roughly

$100M vega (the amount typically traded over the course
of a week) throughout 2015. Given the low demand for

7
Equity allocations are now below 10% across Europe, including from 0 to
Source: Credit Suisse Equity Derivatives Strategy
5% in some areas where typical allocations were of between 10 and 20%.
19
 EQUITY DERIVATIVES STRATEGY

European Insurance Solvency Update

The low rate environment advocates for higher equity
allocation. A majority of insurers would like to achieve this,
but there are 2 major hurdles:
1) the impact on the Solvency II solvency margin and on
the volatility of the solvency margin, and
2) the profit sharing rule means insurers retain 10% of
the profit while they carry 100% of the risk.
Based on the above, it appears that the first step in order
to increase the equity allocation significantly is to free up
some capital. This can only be achieved by focusing on
the main source of regulatory capital requirement:
Longevity Risk and Credit Risk. Replacing credit risks by
equity risk seems to be a potential solution that few
insurers have been willing to explore.
Solvency II Implementation: the SII margin impact, as
described above, could be challenged arguing that the
transition period during which the regulatory capital
requirement will shift linearly from the SI number to the SII
number gives a lot of room to insurers to take more risk
while still being compliant with their capital requirement.
However, both metrics (SI and SII) will be published from
the start (Jan 2016) and the market will expect
companies to be compliant with SII from 2016, implying a
low-risk stance throughout 2015.

Exhibit 4: Solvency II Full Reporting Begins Jan 2016

Source: Brayan and Spencer

20
 EQUITY DERIVATIVES STRATEGY

Pension Funds Exhibit 1: Pension Funding Deficit Widens to $271B

General Outlook
Two steps forward, one step back. Given the bullish
equity market and heightened rate expectations coming
into 2014, hopes were high that a continuation of both
trends would further narrow the defined benefits (DB)
funding status of US pensions. Aided by a combination of
the equity market rally and increased exposure to
alternatives (ex Calpers), investment gains exceeded
expectations. However, the decline in the benchmark
corporate bond interest rates used to value pension
liabilities dropped by 79 bps reversing the 84 bps Source: Millliman

increase in rates from the prior year. As a result, the

funding status of DB plans fell from 93% at the beginning Exhibit 2: 3: DBs May Be 23% Underfunded by YE 2015
of 2014 to 84.6% heading into 2015. Milliman estimates
this represents a total shortfall of $271B for the 100
largest corporate DB plans, as shown in Exhibit 1.
To make matters worse, these estimates do not reflect
new mortality assumptions based on the changing
demographics of life expectancy. Milliman estimates the
impact of the new mortality tables may increase pension
liabilities by additional 6% to 8%, returning the funding
status to near post-Crisis lows. Source: Millliman

Similarly, although a comparatively overweight exposure to

international equity (particularly US) and domestic bonds Exhibit 3: Global Discount Rate Declines Increased DB Liabilities
contributed to higher investment performance for
Eurozone pension funds, Eurozone pensions were
particularly hard hit by a decline in their benchmark rates
(Exhibit 3). As a result, with the exception of Japan where
a marginal decline in the discount rate helped to
strengthen its funding status, global DB pension liabilities
increased across the board delaying the de-risking
process that began in 2013.
2015 Derivatives Trading Implications
Historically, US and European pension plans have Source: Towers Watson
primarily used options to hedge. However, as we move
further away from 2008 and as overall sentiment for Exhibit 4: Alternatives Now ~20% of Pension Assets
equities remains bullish, interest in hedging (tail risk
hedging in particular) has waned. While we had formerly
anticipated an uptick in the use of options last year as
plans began to derisk, that did not materialize. Thus for
2015, the meager activity we do expect from pensions
will likely take the form of hedging via low vega put
spreads or put-spread collars that, in addition to having
little volatility footprint, contribute to depressed skew
levels. Overall, we expect minimal vega impact at the
market level on behalf of US/Euro pensions in 2015.

Source: Towers Watson, Milliman

21
 EQUITY DERIVATIVES STRATEGY

Exhibit 1: Yield-Enhancement Issuance Rose from to 43%

Structured Products
General Outlook
Amidst the prolonged low interest rate environment, yield
maximization has become an increasingly prominent
motivation for global structured products issuance.
Accordingly, to increase coupons to levels of 7% to 9%,
issuers have been ratcheting tenors beyond 10 years and
increasing the use of barriers and other contingent
structures. Alternatively, investors with shorter investment
horizons have been much more willing to consider worst- Source: Credit Suisse Equity Derivatives Structured Products Group

off correlation structures and single stocks with

embedded short barrier put options. Exhibit 2: Tenor of Notes Issuance Has Ratcheted to 10 to 15 Yrs

As a result, over the last three years there has been a

rapid evolution of short-volatility instruments wrapped into
note or certificate formats, such as autocallables, reverse
convertibles, and callable yield notes. We estimate that
throughout 2014 autocallables and other similar
structures had a consistent new issuance run rate of up to
$7.5B per quarter amidst a market which has grown to
over $150B of notional in the last 5 years.
Thematically, investors have shifted towards commodities
Source: Credit Suisse Equity Derivatives Structured Products Group
based and European underlyings. Of particular interest are
broad market indices that offer high dividend yields such
Exhibit 3: Estimated Size Of The European Autocall Market ($B)
as Eurostoxx-50, FTSE-100, and MSCI EAFE.
Consequently, autocallables linked to the S&P-500/
Russell 2000 and the Eurostoxx-50 currently represent
over 70% of outstanding product in the US and Europe
respectively.
2015 Derivatives Trading Implications
In light of prevailing expectations for sustained low global
interest rates, structured note preference for the coming
year will be highly dependent upon market performance.
Many investors are waiting for an improvement in pricing
conditions (e.g., a correction in equity levels or a spike in
Source: Credit Suisse Equity Derivatives Structured Products Group
volatility) to add to their positions. While investors are still
rolling maturing notes, if the markets pull back due to the Exhibit 4: Vega Profile of a 1Y DOI SX5E Put (Barrier 2,000)
cross-contagion previously discussed, we anticipate a
significant pick-up in traded volumes for income products.
However, if the equity markets extend the global rally into
2015, we anticipate a shift away from income bearing
(short optionality) notes towards uncapped participation
(long optionality) structures such as buffered leveraged
notes. Moreover, because a large portion of European
autocalls are near their knock-out barrier levels, a strong
equity market performance would knock out a large
Source: Credit Suisse Equity Derivatives Structured Products Group
proportion of the current structured product inventory to
the upside8. outstanding should be around $50B, of which $45B would be written on the
SX5E (Exhibit 3) with a typical maturity of 5 years. We estimate that today
the bulk of all outstanding SX5E autocalls have a downside barrier between
8 45% to 55% of current spot (i.e, 1,500 and 1,700), and knock-out barrier
Because European autocalls typically have knock-out barriers set at the
between 97% to 100% of current spot (i.e, 3,100 and 3,200).
spot level, the duration tends to be very short (between one and two years
on average). We calculate that the notional of index autocalls in Europe still
22
 EQUITY DERIVATIVES STRATEGY

The Challenge Of Yield Compression Impact of the SX5E Autocall Market

As shown in Exhibit 1, real bond yields have declined to Europe finds itself squeezed between a general
generational lows. disaffection for riskier assets such as equities, and
record-low bond yields that are sparking a surge in
This presents an unprecedented puzzle for many
alternative yield generating instruments. To a large
segments of the investment community. Lower yields
extent, this is reminiscent of pre-Abenomics Japan,
imply negative impact for typical asset-liability
where inflation, bond yields and equity allocations were
managers as they tend to:
similarly low, and equity volatility was driven by a
increase the current value of future liabilities, booming market for yield-generating, autocall
structures called Uridashi.
reduce returns on hedging portfolios,
Through their retail businesses, investment banks have
increase the risk of assets held (bond become the largest natural buyers of long-term SX5E
durations typically increase with lower yields). volatility and dividends. We calculate that on aggregate,
Thus long term required rates of returns can reach up the rehedging of exotic desks retail trades forces
to 8% for institutions, or 10% for funds. Traditional risk banks to sell up to $6mio vega, and up to $90mio of
premia (equity and bonds), however currently offer dividend futures contracts, for every 1% down move in
yields in the 1% - 3%. As a result, investors have the SX5E index (Exhibits 3 and 4).
investigated ways to generate returns that go beyond Exhibit 3: Expected Agg. Vega Expo vs SX5E
traditional investments.
150
One of the most promising strategies consists of
<2Yrs
harvesting equity volatility risk premiums. By selling 100
>=3yr
volatility risk premia, in the form of structured notes,
Aggregate Vega ($mio)

50 TOTAL
investors are able to supplement traditional avenues of
yield.
0
2,000 2,500 3,000 3,500 4,000
Exhibit 1: US Long-Term Real Yields At All-Time Lows
(50)

(100)
SX5E Level

Source: Credit Suisse Equity Derivatives Strategy

Exhibit 4: Expected Agg. Dividend Expo vs SX5E

3,000
2,500
<=2Yrs
2,000
>=3yr
Aggregate Div Exposure

1,500
TOTAL
1,000
Source: Credit Suisse Equity Derivatives Strategy 500
Exhibit 2: Change in S&P Vol Risk Premium vs 10Y Yield 0
(EURmio)

30% 2000 2500 3000 3500 4000

-500
1997-2014
6M Change in SPX 6M Vol Premium

20% -1,000
Last
10% -1,500
SX5E Level
0%
-3 -2 -1 0 1 2 Source: Credit Suisse Equity Derivatives Strategy
-10%

-20% For an in depth discussion of the impact of the autocall

market on the following popular trades: long SX5E call
-30%
options; Long SX5E/Short S&P Dec17 Implied Vol or
-40% Variance Spreads; long SX5E dividends, please see
6M Change in US Gov 10Y Yield
our report dated November 2014:
Source: Credit Suisse Equity Derivatives Strategy (Click here for full report),

23
 EQUITY DERIVATIVES STRATEGY

Systematic Investment Strategies due to the large dividend overhang resulting from
structured products trading, but also stock specific news.
General Outlook
Most strategies, similarly to Credit Suisse Dividend Alpha
The evolution of index products took an accelerated turn index, are closing the year flat/marginally higher.
post financial crisis, when investors went beyond better
Tail Hedging/Hedging
stock picking methods (also referred to as smart beta or
intelligent indices) to embed actual systematic strategies Amongst the greatest challenges of installing a systematic
within indices. Today, these tools have found applications tail hedging program is paying for decay when
across a wide swath of users from pension funds, to asset purchasing options that is to say, option premium is
managers, and even retail investors. 3 key areas of focus expensive, but options often expire worthlessly. In the
in 2014 have been: absence of any real tail event since 2011, the
risk premia capture performance of Tail Hedging strategies in 2014 has been
tail-hedging, and negative across the board, with the most important
cross-asset portfolio investment strategies. differentiating factor being how exposure to the underlying
hedging strategy is sized in times of quiet markets.
As the use of systematic indices continued to grow rapidly
in 2014, index products struggled in 2014 to provide In order to combat the drag of decay, Credit Suisse
performance in-line with past performance. This is less launched the Dynamic Tail Hedge series, which offers
true for cross-asset investment strategies, where the investments in delta-hedged, vega-neutral put ratios on
resulting larger flows have been more easily absorbed due S&P and SX5E based on signals calculated from equity
to the high liquidity of the underlyings. volatility skew and credit spreads (Bloomberg Tickers
CSEADTSP and CSEADYTL). Despite a couple of false
Risk Premia
positives this year, indices are down between 3 and 5%
The concept of capturing risk premia today includes the this year, compared to up to 15% for other less efficient
realm of structured derivatives. Once the domain of hedge hedging strategies.
fund traders, sophisticated derivative ideas can now be
With another strong year expected in Equity markets in
found embedded into indices which have distilled those
2015, hedging strategies are expected to underperform
strategies into its essential elements, via systematic rules-
again although a couple of catalysts (see Tail Catalysts
based trades. Examples of those systematic strategies
section) could create temporary jumps in performance.
for capturing risk premia include:
volatility risk premium, Cross-Asset Portfolio Investments
dividend yield curve, and There has been a growing desire by institutions and
mean-reversion private investors alike, to find systematic and disciplined
All of which have suffered disappointing performance in approaches to managing cross-asset portfolios, by using
2014, due to unusual dynamics in volatility or dividends in either index swaps or ETFs as components of a balanced
2014 resulting from dislocations caused in other investment strategy. In many of these indices, the size of
segments of equity derivatives investing. each constituent exposure is determined using modern
portfolio theory, with an overall volatility target to control
Volatility Risk Premium attempts to capture the volatility the cost of the options linked to it.
risk premium of the equity markets. Volatility risk premium
strategies in their wider acceptance include short variance Credit Suisse RAII HOLT, STAA, ARROW and TEMPO
or short vol-of-vol strategies, and VIX futures roll down indices (the latter one, Bloomberg CSEATMPE, launched
strategies. Performances have generally been in 2013 to address the growing desire of investors to also
disappointing in 2014, in particular due to an unusually obtain exposure to the VIX an asset that provides a
positive spot/volatility correlation leading to misleading built-in tail hedge in times of market stress), have seen
trade signals for strategies timing their exposure based on significant inflow from clients. With large asset rotations
spot performance or volatility term structure, or ineffective expected in 2015, stemming from potential QE in the
hedges for strategies going short vol/short delta. Eurozone in H1, continuing commodities volatility or a
However, strategies that simply go short variance, in possible rate hike in the US in H2, we believe this type of
particular on the S&P, have outperformed. strategy will continue to attract investors attention in
2015.
Dividend Yield Curve Arbitrage: as discussed in page 41,
dividend strategies, most of which are benchmarked on
the SX5E dividend futures market, have been hurt in
2014 by the deterioration in the risk reward of dividends
24
 EQUITY DERIVATIVES STRATEGY

Summary: VIX Forecast For 2015

With the Fed set to raise rates and with several key macro
risks looming on the horizon, we believe 2015 will be a
higher volatility year than 2014. Our VIX scenarios below
use the framework detailed on page 2 of this report,
which decomposes implied volatility into 3 components:
baseline volatility (see pg 3), kurtosis premium (pg 4-11),
and skew premium (pg 12-17). We then analyze the
possible range the VIX could trade in over the next year
by overlaying potential shock scenarios.
Our steady-state scenario evaluates the case where no
major macro catalysts occur and the current economic
recovery continues unimpeded. In three other scenarios,
we estimate the increase to kurtosis and skew if one of
our top 3 macro catalysts a Russian default, euro
breakup, and interest rate shock were to happen.

Our findings are summarized below. In our steady-

state scenario, we estimate the VIX will trade at an
average of 18 over the next year, representing a 4 vol
pt increase from the 2014 average. However, if any of
the negative macro shocks we outlined were to occur, we
estimate the VIX could trade in the 30-40 range.

Exhibit 1: Steady-State VIX Forecast of 18%

Source: Credit Suisse Equity Derivatives Strategy

25
 EQUITY DERIVATIVES STRATEGY

Exhibit 1: High div yield sector performance decelerated in 2H14

2015 Sector Volatility Outlook while low div yield sector performance accelerated
Several overarching themes that initially surfaced in 2014
will become the primary drivers for US equities in 2015 -
namely the impending Fed rate hike, the collapse in oil
prices, and the strong dollar. These themes, in
combination with a bottoms-up fundamental analysis, help
shape our key sector volatility outlooks, detailed in the
next few pages.
Economic Outlook: CS economists see 2015 as a year
of accelerating global growth with expectations for global
GDP to increase 2.9%. While the US has missed its 3%
GDP growth estimate the past four years, CS expects the
US to finally achieve the 3% target in 2015 aided by an
Source: Credit Suisse Equity Derivatives Strategy
improving labor market, supportive housing sector, and
falling oil prices. Though a looming rise in US interest Cyclicals tend to outperform as yields rise and sustain
rates is no new news, a key risk is that the first hike their outperformance following the first Fed rate hike. As
comes earlier than expected. a result, cyclical volatility should continue to drift lower in
2015 while the outlook for defensives is more turbulent.
Earnings Growth: CS forecasts S&P earnings will
The read-throughs for volatility began materializing in
increase 7.9% in 2015, roughly in-line with consensus
2014 as the three most volatile sectors were all
and versus 2014 estimated growth of 6.2%. Consumer
defensives and three of four least volatile sectors were
Discretionary (+17%), Materials (+14%), and Financials
cyclicals. Defensives have not claimed more than one
(+13%) are expected to lead the growth while Utilities
spot of the top three, nor have cyclicals claimed more
(+3%) should lag behind along with Energy (-17%), the
than one spot of the bottom four, in at least five years.
only sector with negative growth expectations. Of note,
2015 earnings estimates for Energy have declined 2,470 Key Sector Volatility Views:
bps since the end of 3Q with 24 of 43 S&P companies
seeing downward revisions of 20% or more Energy: We think 2015 vol could be higher yet as
oil prices search for a bottom and the longer-term
Interest Rates: CS economists expect the Fed will begin consequences of low oil prices begin to play out.
raising rates in June 2015, slightly earlier than the
Technology: We expect Technology volatility to
consensus expectation for August. Our Fixed Income
move lower given strong growth prospects, low
team forecasts that by year end 2015, 10-year yields will
financial leverage, and compelling valuation.
rise to 3.35% (vs 2.12% currently) and 2-year yields will
Healthcare: Increased M&A, continued pipeline
rise to 2.00% (vs 0.66% currently).
catalysts and stretched valuations should keep a
High dividend yield stocks tend to underperform when bid under Healthcare vol in 2015. The drug
Treasury yields rise and there is a strong negative pricing debate and new Congress provide
correlation between the performance of dividend yield as a additional headline risk.
style and US bond yields. Consequently, CS equity Exhibit 2: 2015 Sector Volatility Outlook
strategy remains cautious on dividends as a style in the
Weight in 1Y Rlzd 1Y Impl Volatility
US for 2015 and recommends focusing on buybacks
S&P Volatility Volatility Sector Outlook
instead. 20% 12.8 18.6 Technology
17% 12.9 18.3 Financials
Indeed, the early signs of a divergence in performance
14% 14.5 19.1 Healthcare
can be observed in 2014 where the mean US 2-year yield 12% 13.3 17.7 Consumer Discretionary
increased to 0.51% in the second half of the year versus 10% 13.8 17.0 Industrials
0.38% in the first half. Four of five sectors with the 10% 9.8 14.4 Consumer Staples
highest dividend yields exhibited decelerating performance 8% 18.5 23.4 Energy
3% 13.7 18.1 Utilities
in 2H14 vs 1H14, with three recording negative absolute
3% 14.2 19.9 Basic Materials
performance. Conversely, all five of the sectors with the 2% 14.7 17.9 Telecom Services
lowest dividend yields demonstrated accelerating
performance in 2H vs 1H, with all five also registering Lower Volatility
positive absolute performance. Higher Volatility

Source: Credit Suisse Equity Derivatives

26
 EQUITY DERIVATIVES STRATEGY

Energy: Oil Vey! Natural Gas Outlook: CS expects an average price of

$3.85MMBtu in 2015, down 12% from 2014. The
Energy enters 2015 on the back of its most volatile one-, above-consensus forecast largely rests on expectations
three-, and six-month period since early 2012, though for supply trends to moderate given the impact of lower oil
surprisingly XLE one year realized volatility of 18.5% is prices on capex and upstream activity and a rebound in
still below the 19.2% that was implied by the market at electric utility demand for gas. Winter weather remains a
the beginning of the year. Energy experienced severely wildcard that will dictate the amount of supply in storage
bifurcated vol regimes in 2014 with 6M realized volatility at the end of the season. The potential surplus or lack
midway through the year of only 12% while by year end thereof brings significant uncertainty for prices, with CS
6M realized volatility nearly doubled to 23%. We expect identifying possible outcomes anywhere in the $3-
Energy volatility to move higher in 2015. The first part of $5/MMBtu range.
the year will see companies clambering to adapt to the
Exhibit 3: Energy Subsector Sensitivity to Oil Prices
new environment as oil prices continue searching for a
bottom. In 2H15, despite CS Energy teams expectation Beta Correlation
4Q14 2014 4Q14 2014
for a recovery in oil prices, we will start to see the longer-
E&P 1.13 0.71 0.76 0.63
term effects of low prices throughout the sector including
Servicers 1.00 0.66 0.80 0.64
M&A, restructurings, capital allocation changes, and Integrated 0.86 0.45 0.81 0.53
possible liquidity issues. Clear winners and losers will Refiners 0.92 0.26 0.81 0.23
emerge, which should keep a bid under volatility. Though Source: Credit Suisse Equity Derivatives
the sector is trading at a P/B relative near all-time lows,
Exploration & Production: Despite the sharp pullback in
CS doesnt find all laggards cheap and still finds value in
stock prices, CS recommends defensive positioning
some of the better performing subsectors, suggesting
through what should prove a challenging 2015 for the
stock picking will continue to be important for longer-term
E&Ps. We see the primary differentiators for stocks as:
investors.
Exhibit 1: Sector Scorecard Capital: With E&Ps the most sensitive subsector
2014 Implied 2014 Realized 2015 Implied to oil prices and one of the most capital-intensive
Vol Vol Vol groups in the S&P, cost of capital and access to
Energy Sector 19.2 18.5 23.4 capital will come center stage. In a prolonged
Source: Credit Suisse Equity Derivatives downturn, companies with highly leveraged
Oil Outlook: Oil is in for another volatile year as markets balance sheets will face more limited funding
wade through uncertainty regarding the timing and scope options and may be forced to seek M&A or
of the supply side response to low prices. Seasonal higher cost of capital options. The amount of
factors suggest the bottom could still be ahead of, but oil E&P high-yield debt outstanding is up 75% since
prices should subsequently reach a trough low in 1Q15 as 2011 while total indebtedness has grown by
most US firms disclose their capex plans for the year and more than 100%. E&P yields in the high yield
other leading indicators of slowing US supply growth market have nearly doubled in the last three
begin to emerge. Prices should recover some lost ground months alone. Meanwhile, CS estimates the
from there, with a key tenet of CS Energy Teams 2015 industry will outspend its cash flows by 148% this
outlook that markets will normalize at a higher price than year.
current spot levels with a base case of $70 WTI. (See Oil Exhibit 4: E&P High Yield Debt Outstanding and Yield
page below for more details)
Exhibit 2: Projected tracks of monthly oil production (all liquids) in
the U.S.

Source: Credit Suisse Equity Derivatives, Credit Suisse Fixed Income

Source: Credit Suisse Research, EIA Research Estimates
27
 EQUITY DERIVATIVES STRATEGY

Asset Base: Core franchise assets that provide Refiners: Despite significantly outperforming other
inventories of low-cost and low-risk development Energy sectors and the S&P, there is still the prospect for
opportunities will become even more crucial in a higher highs for Refiners heading into 2015. Several
lower price environment. CS views the Marcellus, positive factors should offset potential margin headwinds
Utica, Permian, and Niobrara as the most in 2H from lower onshore drilling activity and weak EM
powerful franchise assets that should continue to demand. In particular, substantial self-help opportunities
outperform while 70% of Bakken wells and 40% for the group can drive modest EBITDA growth.
of Eagle Ford wells are at risk.
Trade Recommendations
Oilfield Services: CS expects a trading opportunity to
See Trade Idea section for more details
emerge in 1Q15 to buy the group as oil prices bottom and
seasonality turns favorable. However, we maintain a Buy XLE 1Y implied vol; Sell USO 1Y implied vol
Market Weighting on the group as it may turn out to be a Despite seemingly elevated levels of 23%, we think
short-term trading opportunity rather than a fundamental XLE implied volatility could still move higher as there
bottom. If activity and budget weakness persists long are many catalysts yet to come as the longer-term
enough, disappointment could push stocks lower again consequences of lower oil prices begin to play out in
and the focus for asset-based and smaller-cap service 2015. However, we recommend using a short USO
companies will shift to balance sheets and survivability. volatility position as a hedge in case oil markets settle
Large-cap OFS companies that gain market share in and dampen energy volatility more than expected.
down markets, lead in pricing with technology, and have a USO vol is trading at an all-time high versus XLE vol,
more diversified revenue base are best positioned. making the trade attractive on a relative basis as well.
***The risk to selling volatility is unlimited. The risk to buying volatility is
Exhibit 5: Credit Suisse Oil Field Services Timing Model suggests a
trading opportunity to buy the group in 1Q that volatility could go to zero.

Buy XLE 1Y ATM down-and-in call Our Energy

Teams 2015 Outlook calls for oil prices to trough
during 1Q15 followed by a recovery throughout the
remainder of the year, normalizing at a price higher
than current spot. For investors who believe that
Energy stocks will follow a similar trajectory, we
recommend the purchase of a one year at-the-money
down-and-in call on XLE with a knock-in barrier at
90% for the first three months (daily observation). This
option is currently priced at a 73% discount to a 1Y
vanilla ATM call. ***The risk to buying a down-and-in call is losing
premium paid.

Source: Company data, Credit Suisse estimates Buy USO 1Y ATM up-and-out call A key tenet of
Integrated Oil: CS Energy maintains a Market Weight our Energy Teams 2015 Outlook is that oil prices will
rating on the group, but prefers European majors over normalize at a price higher than current spot but fall
their US peers due to lower sensitivity to oil prices and far short of average levels seen over the last five
cheaper valuations. Key focus areas in 2015 will be: years. For investors who believe oil will recover, but
only a portion of its losses of the last three months, we
Dividends: Protecting the dividend is a central recommend the purchase of a one year at-the-money
priority for the Majors. While all of the Integrateds up-and-out-call with a knock-out barrier at 130%
are expected to have a FCF yield below their (daily observation). This option is currently priced at an
dividend yield in 2015, CS believes an improving 89% discount to a 1Y vanilla ATM call. ***The risk to buying
cash cycle can help support a 5%+ dividend yield an up-and-out call is losing premium paid.
for the group at $65/bbl Brent.
Megaproject Execution: Project delivery will be
the key to driving a sustainable shift in cost
structure and cash flow growth. The industry will
need to improve its track record substantially after
destroying value relative to initial NPV
expectations on 75% of all projects in the last
decade.
28
 EQUITY DERIVATIVES STRATEGY

Oil: Framing the Great Debate

We learned in 2014 that $110 per barrel global oil prices are too high, since they generated the supply-growth surge
that tipped Brent and WTI oil prices out of the trading ranges they had been stuck in since 2010. Equally, we think
that $60/b oil prices are too low to fund the supply effort required. Now, absent Opec, oil markets are doing what
they are supposed to be doing, which is to price toward a recalibration of supply and demand. Four dynamics that
we think are critical to 2015 oil price tracks, in order:
(1) Pace and timing of industry-driven slowdown of oil supply growth
Near term this is largely (though not exclusively) a U.S. story.
(2) Sovereign producer behavior
Will Opec (read Saudi Arabia) and/or Russia act and cut supply soon; or in future, at what price could Opec
come together?
Disruption potential, exacerbated by low prices, involves in order of relevance: the new U.S. Senate
tightening sanctions on Iran; Nigeria's presidential elections in February and winter in Europe.
Unquantifiable risk, alphabetically: Algeria; Iraq/Syria; and Libya.
(3) The degree to which oil demand will follow the near term bounce in global IP
We prefer industrial production as the key macro driver. Its growth decelerated sharply in 2014 and passed
the trough-low already.
But regional policy divergence is our key macro-theme for 2015
(4) Growth of refiner demand for black oil should re-accelerate
Albeit only a step-change confined to 2015, driven by marine fuel
Distribution of that growth depends on capacity-adds / -cuts

Upside Drivers: Downside Surprises:

US Supply: A score of companies have already US Supply: Hinges on the behavior of hundreds of
announced deep cuts to capital spending, individual, profit-driven entities that may not be
indicating lower volume growth perfectly rational actors
Sovereign Producers: Sovereigns pushed to the Sovereign Producers: Progressive sanctions relief
breaking point could persuade Saudi Arabia to call on Iran result in increased exports; agreement with
an emergency Opec meeting worry most about Iraqs Kurds allows for higher production
Nigeria and Algeria Demand: Global demand decelerates as global IP
Demand: An economic recovery in the US could tilt remains mired on a lower track; China, Russia,
the fairly flat oil demand track meaningfully higher Japan, and US continue to disappoint relative to
forecasts
Exhibit 1: We forecast much reduced non-Opec production
growth [YoY chg of non-Opec oil supply (all liquids) in Kb/d] Exhibit 2: WTI skew is at one-year highs, indicating the market is
still bearish on oil prices

Source: Credit Suisse estimates Source: Credit Suisse Equity Derivatives Strategy
29
 EQUITY DERIVATIVES STRATEGY

Technology: Growth Spurt Intact issue of security into the spotlight. This will
continue to drive spend in 2015 as companies
On the heels of three consecutive years of double digit ramp up security efforts to avoid facing
returns, Technology enters 2015 well positioned with CS reputational damage and lost revenues. The ISE
macro strategists forecasting tech investment growth to Cyber Security Index has outperformed the S&P
accelerate to 6-7% from 2.2% currently. Additionally, by 11% in 2014 and by 6% since news of the
Technology has one of the lowest financial leverage Sony hack broke.
levels, creating a favorable set up against a backdrop of
Exhibit 2: Number of data breaches has been growing steadily and is
higher interest rates. Combining these factors, we believe up 26% in 2014
Technology volatility will be lower in 2015. Attractive
valuation should also help temper volatility, with the
sectors P/E relative to the market near a 20-year low.
Exhibit 1: Sector Scorecard
2014 Implied 2014 Realized 2015 Implied
Vol Vol Vol
Technology Sector 16.7 12.8 18.6 Source: Identity Theft Resource Center, Credit Suisse Equity Derivatives
Source: Credit Suisse Equity Derivatives IT Hardware: IT Hardware faces several headwinds in
Semiconductors: While cyclical factors may cause some 2015 as CS Research expects already-muted Hardware
concern, we continue to be bullish on the industry and see IT spending to decelerate further to just 2.5% y/y and
reasons to own the group, namely expectations for more sees mounting disruption from new technologies. The rise
stable and sustainable growth. Key debates to watch: of the cloud will increasingly challenge todays traditional
IT incumbents and we expect a major transition towards
Cyclical Factor: Historically, semis have been one the Public and Hybrid Cloud, evidenced by the rapid
of the most cyclical industries. Several cyclical expansion of Amazon Web Services. Software-Defined
metrics have started to roll over, suggesting the Networks pose a threat to legacy switch and router sales,
group could be due for some underperformance. as does a slowdown in carrier capital spending. In
However, semi mgmt teams have recently addition, relative book-based valuations are now at twelve
indicated the industry is shifting away from its year highs and the group has significantly re-rated relative
traditionally cyclical nature and becoming more to the broader tech sector over 2014.
stable. This echoes the sentiment of our research
Exhibit 3: IDCs survey of >1,000 major enterprises indicates a clear
team who believe the more constructive structural shift from Traditional IT to the Public and Private Cloud
elements of the industry will now dominate.
Structural Factor: The outlook for the structural
dynamics that will support the group in 2015 is
decidedly rosier. Barriers to entry continue to
increase, providing a foundation for more stable
pricing. Consolidation and end-market
diversification should help push the industry to
GDP-plus growth from GDP-minus growth for
the first time since the mid-1990s. Consequently,
our Semi Research team sees at least 20-25%
upside for the group in coming years.
Software: CS further increased its largest sector Source: IDC CloudTrack Survey Credit Suisse Equity Research
overweight recommendation for 2015, arguing European
and US software offer the best combination of strong Trade Recommendation
fundamentals and low valuation. Software should continue See Trade Idea section for more details
its track record of above average growth driven by We recommend a short Technology volatility position
continued development of areas such as big, fast data for 2015. Despite its strong fundamental outlook,
and software-as-a-service. We see a notable theme for Tech 1Y implied vol is currently in the 97th percentile at
2015 as: 19%. Tech implied vol is the fourth highest of the ten
Security: Several high profile data breaches major sectors, though it has realized the second-to-
dominated headlines over the last year (TGT, lowest volatility of the sectors in each of the past two
JPM, Sony Pictures, etc.) and are forcing the years. Additionally, the spread between implied and
realized vol is close to two-year highs. ***The risk to selling
volatility is unlimited 30
 EQUITY DERIVATIVES STRATEGY

Healthcare: Catalysts Galore Exhibit 3: Record Year for Biotech / Pharma M&A

The second best performing sector in 2014, Healthcare

enters 2015 with a landscape chock-full of catalysts.
Pipeline readouts, the drug pricing debate, M&A, and
political uncertainty should drive volatility higher in the
coming year.
Exhibit 1: Sector Scorecard
2014 Implied 2014 Realized 2015 Implied
Vol Vol Vol
Healthcare Sector 15.1 14.5 19.1
Source: Credit Suisse Equity Derivatives

Biotech: Biotech has been the best performing sector for Source: Credit Suisse Research, Thomson Reuters, Bloomberg
four years in a row with returns of 33% in 2014 alone and
of 293% over the last four years vs 84% for S&P. Drug Pricing: Responsible for generating multiple
Propelled by M&A and pipeline catalysts, Biotech has headlines and patches of choppiness in Biotech and
potential to continue its hot streak. We expect Biotech will Pharma stocks this year, drug pricing will become even
outperform the broader market in 2015, and may even more of a hot button debate in the press and in the stock
retain its #1 position. market in 2015. The issue was previously viewed primarily
as headline risk rather than a significant near-term threat
Pharmaceuticals: With sector valuation near multi-year to earnings, but the late December deal between AbbVie
highs after a strong 201 `4, pipeline progress and and Express Scripts represents a substantial turning point
additional M&A will be necessary to drive continued in the narrative and creates considerable uncertainty
upside. Premium valuation means stock picking will heading into 2015. Investors will be closely watching for
become even more important, and the catalyst-rich clues as to whether drug pricing overall is now at material
landscape provides opportunity for alpha generation. risk or whether the issues will be contained to hepatitis C.
Exhibit 2: Pharma FY1 P/E vs S&P 500 In the case of the former, there could be far-reaching
ramifications on the profitability and valuations of the
sector. An area of particular concern is oncology, as it is
currently the top spending therapeutic area and has seen
median drug prices have double over the past decade.
Exhibit 4: Biotech implied vol spikes to 8M high and Pharma implied
vol to 1Y highs following AbbVie / Express Scripts deal

Source: Credit Suisse Equity Research

Central elements affecting Healthcare in 2015 are:

M&A: Biotech / pharma total M&A deal value surged to
its highest ever level in 2014. With several failed acquirers
(PFE, VRX, ABBV) likely still interested, deals should to
continue to materialize in 2015. Large cap biotech could
Source: Credit Suisse Equity Derivatives Strategy
start to get more involved as pipelines mature and balance
sheets remain robust, while specialty pharma will be a Politics: A number of political and legislative catalysts in
particularly coveted asset. Though valuations have 2015 have the potential to disrupt momentum in various
remained reasonable, the trend has shifted towards large healthcare industries. Republicans gained a majority in the
scale deals. Average deal size was the largest since 2009 U.S. Senate in the 2014 midterm elections, giving them
and there were three deals valued over $10B (for control of both houses of Congress and paving the way
comparison, deals >$10B totaled only five over the last for possible changes to the Affordable Care Act.
five years). The willingness to execute larger-scale M&A Additionally, the Supreme Court will hear cases that look
creates more possible targets by opening the door for to chip away at parts of the law. Other potential catalysts
deals that would have previously been deemed too big. include the doc fix set to expire in March.
31
 EQUITY DERIVATIVES STRATEGY

European Sector Volatility Outlook Key European Sector Views

As shown in Exhibit 1, European sector options have
relatively low liquidity compared to their US equivalents,
Too Much Pessimism on European Growth with total listed open interest more than EUR1B on only
CS Global Equity Strategy expects Europe to perform well two sector indices: SX7E (Eurozone Banks) and SXPP
in 2015 (15% upside with a year-end target price of (Europe Basic Resources). There is, however, much
3600 for SX5E) with three main drivers behind this view: deeper liquidity in the OTC market for several sectors.
With almost EUR16B notional of listed options, SX7E
Growth: CS economists forecast European growth to remains by far the most liquid sector index in Europe.
recover modestly in 2015 with GDP to rise of 1.1%. The SXEP (Oil & Gas) open interest increased by more than
environment is much more supportive than 2014: bank 100% year-on-year (from EUR300mio to EUR713mio)
balance sheets have stopped contracting and are healthier after oil prices fell to $50.
post AQR stress test, and a sustained weaker euro and
falling oil prices could boost European GDP by 0.8%. Exhibit 1: European Sector Options Liquidity (Pre-Dec expiry)

Monetary Policy: Global Strategy believes full-scale QE Call OI Put OI

(including the purchase of sovereign bonds) will be Notional Notional Total
announced early this year. We expect it will be more Ticker Name (EURmio) (EURmio) (EURmio)
effective than investors realize, with as much as 650bn SX7E ESTX Bnk Pr 10,030 5,923 15,953
SXPP STXE 600 BsRs Pr 785 388 1,172
of extra bond buying (7% of GDP) required to expand the SXEP STXE 600 Oil&G Pr 471 242 713
balance sheet by 1trn over the next 2 years. SX6E ESTX Util Pr 409 230 639
SX7P STXE 600 Bnk Pr 526 96 622
Earnings: While European earnings remain 40% below
SXEE ESTX Oil&G Pr 440 33 473
their pre-crisis peak (vs. 20% above in the US), there are SXDP STXE 600 HeCr Pr 270 42 312
signs of a turn in earnings revisions relative to global SX6P STXE 600 Util Pr 42 67 109
markets. CS forecasts Euro Area earnings will grow by Source: Bloomberg, Credit Suisse Equity Derivatives Strategy, as at date 18 Dec 2014

8.2% in 2015, with a further weakening in the euro Generally, sector volatilities have picked up in H2 2014
providing an extra boost. CS forecasts 1.15/$ for end after falling to multi-year lows in H1 2014, in parallel with
2015 and estimates a 10% decrease in the Euro would European index volatilities. We find that 3-month implied
give rise to an 8% increase in earnings. volatilities across European sectors are all trading above
Overall, the 2015 European equity outlook favors QE the 95th percentile over the past year (Exhibit 2). Volatility
beneficiaries (such as Banks), big dollar earners skew is also steep across the board, except for:
(Pharmaceuticals, Autos), and dividend payers Banks: mainly due to large buyers of upside calls
(Telecoms); while energy (except integrated companies), ahead of a potential QE announcement
mining and consumer staples are expected to Miners: due to large positions in out-of-the-money
underperform the market. calls following the strong underperformance of the
sector for most of H2.

Similar to the SX5E, sector volatility term-structure is

inverted across the board, due to the presence of major
catalysts early this year (ECB meetings of January and
March, Greek elections at the end of January).

Exhibit 2: European Sectors Volatility Snapshot

3M Imp 3M 90- 1Y-3M Term-
Ticker Name Vol Perc 110 Skew Perc Structure Perc
SX7E ESTX Bnk Pr 31.1% 98% 3.7% 29% -6.6% 1%
SX7P STXE 600 Bnk Pr 24.4% 97% 3.4% 44% -4.3% 2%
SX6E ESTX Util Pr 20.9% 95% 5.8% 96% -5.4% 2%
SXEP STXE 600 Oil&G Pr 27.5% 97% 5.0% 94% -7.5% 2%
SXPP STXE 600 BsRs Pr 25.7% 96% 3.6% 66% -3.9% 4%
SXDP STXE 600 HeCr Pr 16.3% 97% 2.7% 81% -3.7% 4%
SXEE ESTX Oil&G Pr 28.4% 98% 5.5% 90% -8.1% 1%
SX6P STXE 600 Util Pr 19.5% 98% 4.5% 71% -4.7% 2%
Source: Bloomberg, Credit Suisse Equity Derivatives Strategy, as at date 2 Jan 2015

32
 EQUITY DERIVATIVES STRATEGY

European Banks (overweight): CS Global Equity Strategy

expects European banks to outperform in 2015. Retail
banks and wholesale banks should lead the group, while Exhibit 4: SXPP 3-month Skew
investment banks were downgraded to underweight. Bank
balance sheets are healthier following AQR stress tests
and their cost of equity has declined sharply (as proxied
by European bank CoCo yields which have fallen to 5.5- 40.0%

6%). There is significant upside potential to bank earnings

Volatility (%)
due to falling provisions, while ECB action could also 35.0%
provide a major boost to banks valuations (sovereign QE,
development of securitization market). At 31.1%, 3-
month implied volatility appears high versus both its recent 30.0%
history and other European sector volatility. However, it is
still trading far below levels reached in 2008, 2010 or
2012 as seen in Exhibit 3. 25.0%
50Pct 75Pct 100Pct 125Pct 150Pct
Exhibit 3: SX7E 3-month Implied Volatility
.SXPP 3M Skew (1/2/2015 Close)
90% Source: Bloomberg, Credit Suisse Equity Derivatives Strategy, as at 2 Jan 2015

80%

70%
Exhibit 5: SXPP 3-month Implied vs. 1-month Realised Volatility
60%
1.6
50%
1.4
40%
1.2
30%
1
20%
0.8
10%
0.6
0%
2007 2008 2009 2010 2011 2012 2013 2014 2015 0.4

Source: Bloomberg, Credit Suisse Equity Derivatives Strategy 0.2

0
Basic Resources (underweight): While CS Global Equity 2008 2009 2010 2011 2012 2013 2014
Strategy remains underweight on Miners (over 70% of the 3M Implied Volatility 1M Realised Volatility
SXPP Index), they have recently become more positive on
Source: Bloomberg, Credit Suisse Equity Derivatives Strategy, as at 2 Jan 2015
the sector due to:
1) more attractive valuations: basic resources have
been the second worst performing index sector in
Europe at -6% vs. Stoxx 600 benchmark up
4.4% Trade Recommendation
2) significant capex cuts: have put a greater focus With SX7E lagging SX5E by 6% in 2014 and
on shareholder returns; European Banks expected to outperform in 2015,
3) temporary signs of stability in China; particularly in case of a QE announcement, we suggest
4) iron ore at more reasonable prices. going long call spreads on SX7E (see page 48).
While the sector has already rebounded by 10% since
***The risk to buying a call spread is limited to premium paid
December lows, we suggest investors looking for further
upside to go long call spreads to take advantage of the
relatively flat skew (Exhibit 4). At 25.7%, 3-month implied
volatility is trading relatively expensive versus its recent
history, but still well below 2010-2011 levels. It also
screens cheap versus recent realized volatility of 30%
(Exhibit 5).

33
 EQUITY DERIVATIVES STRATEGY

Correlation Outlook SX5E Dispersion

Due to its smaller number of constituents and less
In 2014, the buzz amongst the correlation trading diversified structure, the SX5E correlation typically
community was that S&P realized correlation had fallen to realises about 10 higher than the S&P correlation. Since
15-year lows. Interestingly, although the year yielded an 2011, this difference has now risen to about 15
extraordinary number of idiosyncratic catalysts including correlation points, due to the sustained rally in the S&P
the highest number of M&As since 2007, average single and the succession of Euro-centred sell-offs.
stock volatilities remained fairly stagnate at 20%. As a
result, deviations from the average S&P realized The SX5E index correlation has realised 57% in 2014, in-
correlations of 36% (versus our forecast of 33%) as well line with the ATM implied correlation at the beginning of
as the year-end correlation regime shift9, came largely on the year. Similarly to the S&P, SX5E 3M realised built up
the back of index volatility fluctuations (or lack thereof) in from relatively benign levels in H1 2015 to reach over
response to changes in broad market sentiment. 70% in the last quarter after SX5E suffered two sell-offs
Consequently, although dispersion trades are usually in quick succession.
determined by the net interaction between index and
single stock volatilities, the current stability of single stock Exhibit 2: SX5E Rolling 3M Realized Correlation (Top 50)
vols leading up to 2015 suggests that the profitability of
dispersion trades will be largely determined by the index
volatility leg. (Exhibit 1).

Exhibit 1: S&P Rolling 3M Realized Correlation (Top 50)

Source: Credit Suisse Equity Derivatives Strategy

SX5E Correlation Forecast

A strong rebound in the SX5E in H1 2015 is expected to
Source: Credit Suisse Equity Derivatives Strategy
result in a decidedly lower realised correlation. As shown
on Exhibit 3, a 10 to 15% rebound in the SX5E should
S&P Correlation Forecast yield a realised correlation of down to 45% versus a
Our implied correlation forecast is constructed using our current 1Y implied in the high 60s.
index implied volatility forecast (VIX at 15, see pg 21) and
our sector level implied volatility forecasts (see pg 23). In Exhibit 3: SX5E 6M Realised Correl vs 6M Return Scenario
contrast, our realized correlation forecast is based upon
the Monte-Carlo scenario analysis described on page 3.
Based on those two techniques we forecast a 1Y implied
and realised correlation for the S&P 500 of 58% and
36%, respectively.

9
Low Correlation Regime: In the first three quarters of 2014 while
the S&P volatility was realising not far from 2004-2006, Great
Moderation levels, the S&P 3M correlation realised below 40%
Higher (Current) Correlation Regime: In Q4: with two market sell-off
episodes in October and again in December, S&P correlation realised
between 40% and 50%.
Source: Credit Suisse Equity Derivatives Strategy
Historically, the S&P index correlation realises around 35% during periods
of sustained bull markets, while this correlation then rises to 40 to 50% in
times of market correction.

34
 EQUITY DERIVATIVES STRATEGY

Seller Beware! Dispersion Trading Challenges: could have gone short correlation in January 2014 is
~47%, or 6 correlation points lower than mid.
Based upon our projections, there will be a sizeable 22
correlation point difference between S&P implied and Exhibit 5: Actual Short Correlation Level vs Index Implied Vol*
realized correlations. However, we caution that the implied
54%
reflect mid-market levels and that there are specific 53%
challenges with respect to trading dispersion in a low 52%
volatility regime. In this section, we use a case study using 51%
levels from last year to illustrate some of the challenges 50%

Implied Correlation
for dispersion trading presented by the volatility 49%
48%
environment we expect in 2015.
47%
As explained in the text box for var swap dispersion10 on 46%
Correl Actual
the next page, the P&L of a dispersion trade depends on 45%
Mid Correl
44%
two elements: 10% 15% 20% 25% 30% 35% 40%

1) the correlation P&L, and Implied Volatility

2) a scaling factor depending on the level of single Source: Credit Suisse Equity Derivatives Strategy
* Assuming that index and single stock variance bid-ask spread is constant, at 0.6
stocks realized volatility. and 1.5 vol pts, respectively

Additionally, the impact of large bid ask spreads on the Single Stock realized volatilities at all-time lows: as
price of variance or volatility swaps tends to be magnified shown on Exhibit 6, the average, 1Y realized volatility
at times of low volatility further reducing dispersion P&L. of the top 50 S&P constituents in 2014 has been
the lowest since 1997 even lower than during the
The Optics of Pure correlation P&L: In January, 2004-2007 Great Moderation.
mid-prices for a 1Y implied correlation is 53%.
Assuming perfect foresight, a correlation trader Exhibit 6: Avg 1Y Realised Volatility of S&P Constituents (Top 50)
believes that correlation will realize 36% one year
later, which implies a potential correlation P&L" of
up to 17 correlation points. As shown on Exhibit 4,
this would put 2014 on the top 40% of years since
1997, based on this measure.

Exhibit 4: S&P 1Y Implied to 1Y Fwd Realised Correlation Spread*

Source: Credit Suisse Equity Derivatives Strategy

The above explains why, although it has been traded

close to all-time highs for the whole of 2014, the spread
between 1Y implied and realised correlation is still not
converging (Exhibit 7).

Source: Credit Suisse Equity Derivatives Strategy

Trading SX5E Dispersion: overall SX5E presents the
* Spread expressed in correlation points, per trade date on the x-axis dispersion trader with an entirely different puzzle from the
S&P: while the S&P dispersion trades showed positive
Impact of transaction costs: However, the presence correlation P&L but disappointing dispersion P&L due to
of potentially large bid ask spreads on the price of
low single stock volatility, the SX5E has enjoyed in 2014
single stock variance or volswaps, knocks down the
comparatively large levels of single stock volatilities (over
effective level at which correlation is actually sold. As 25%), but virtually zero correlation P&L.
shown on Exhibit 5, this impact is even more
pronounced at times of low volatility such as now.
Thus the effective level at which dispersion traders

10
the situation is not fundamentally different for vol swap dispersion
35
 EQUITY DERIVATIVES STRATEGY

Exhibit 7: S&P 1Y Implied-Realized Correlation Spread

Dispersion P&L Decomposition
In its most generic form, the P&L of a dispersion trade
can be thought of as the spread between the P&L of
an index variance swap and that of a basket of single
stock variance swaps:
( ) ( )

Where:
NI = var notional of index variance swap
I = realized volatility of the index during the life of the
Source: Credit Suisse Equity Derivatives Strategy trade
KI = index varswap strike
Dispersion Trading Opportunities in 2015
Ni = var notional of variance swap written on stock i
We expect the best opportunities for trading dispersion in
2015 to arise from: i = realized volatility of stock i during life of the trade
Opportunistic trades >60: As shown on Exhibit 8, Ki = var strike of long variance swap i
60% implied correlation is the threshold above H = some hedge ratio
which dispersion trades start yielding significant Typically, variance notionals are chosen in terms of
P&L. This was reinforced last year as virtually all
vega exposure:
short correlation trades last year disappointed
with the exception of trades initiated in May and
November when implied correlation exceeded
60%.
Exhibit 8: P&L of 1Y Dispersion Trade vs Mid Correl Level*

Providing identical vega on the long and the short legs

(that is, H=1), and ignoring the constant 100 * vega /
2, the var spread P&L can be rewritten as:

[ ] (1)

Source: Credit Suisse Equity Derivatives Strategy In a well diversified index,

is roughly equal to the
* Vega-flat P&L, for $100 Vega on short index and long single stock variance legs

Customized trades: where the single stocks

picked as part of the long variance basket would realized correlation. (1) is therefore equivalent to:
have seen significant realized volatility. Please
[ ]
see our report The Drivers Of Single Stock
Volatility (Click here for full report), dated October That is,
2014, for more details on how to spot cheap
single stock volatilities.
Fundamental Stock Picking: Interestingly, while [ ].
the stability of single stock volatility allows for
dispersion traders to monetize long stock vol For more details on vega-flat versus theta-flat
trades, it also permits a stock picker to slowly schemes, please refer to our report: Variance Spreads
establish a long stock vol basket traders by And The Variance Risk Premium, dated January 17,
legging into the trade based on fundamentals. 2014)

36
 EQUITY DERIVATIVES STRATEGY

The Divergence Between Inter- vs. Intra-Sector Correlations

Even though S&P realized correlation averaged a benign 35% in 2014, almost unchanged from 2013, looking at
just index correlation would have masked one of the more notable developments in correlation space: the divergence
between inter- and intra-sector correlations

While intra-sector correlations were often elevated

Macro factors such as falling oil prices, beta rotation, and rising interest rates had disproportionate impact on
some sectors, causing correlations to spike as stocks within those sectors traded together.
As we end 2014, realized correlation stands at/near 1-year highs for Tech, Energy, and Staples.
Inter-sector correlation fell significantly in 2014
In contrast, there was a lot of dispersion between sectors. E.g. while Energy and Telecom significantly
underperformed in 2H14, down an average 12%, healthcare and financials rallied over 10%.
Year-over-year, inter-sector correlation is down 10 corr pts to 59% and the spread between inter- vs. intra-
sector correlation has also fallen significantly, turning negative briefly in November (see chart below).

What does this mean going forward?

Sector vs. stock correlation divergence has important implications for market participants.
Portfolio Managers who allocate across sectors likely experience better alpha, as sector rotation
decisions translate into differentiated performance.
Sector-specific PMs and Analysts are likely faced with continued alpha challenges, as stocks continue
to move together within a single sector.

2a. Sectors are Less Correlated with Each Other 2b. Stocks Within Each Sector are More Correlated

Source: Credit Suisse Equity Derivatives Strategy

37
 EQUITY DERIVATIVES STRATEGY

Global Dividend Outlook

Exhibit 3: SX5E Divs Perf and Risk Since 2009*
A profitable trade during economic expansions, the risk/
2009 2010 2011 2012 2013 2014
reward of long global dividend positions has started to Same Year
deteriorate in 2014. Stock specific news and the Performance 14.6% 2.6% 7.1% 8.9% 5.8% 4.7%
overhang stemming from structured products issuance Volatility 6.5% 3.3% 1.9% 4.6% 2.2% 2.7%
Beta 5.3% 2.2% 0.6% 0.5% 1.2% 2.2%
have made the trade less attractive. While global dividend Year + 1
trades still managed to post a positive performance in Performance 58.1% 5.3% -5.4% 18.5% 9.7% 2.6%
2014, the 2015 outlook will be more neutral, with Volatility 21.1% 20.1% 13.7% 12.8% 6.7% 5.5%
Beta 39.8% 61.9% 38.3% 30.8% 20.4% 17.5%
Eurozone (SX5E) dividends in particular being contingent
Year + 2
upon Q1 QE actions. Performance 60.3% 1.4% -16.1% 21.4% 12.3% 2.2%
Volatility 24.8% 23.8% 23.0% 14.1% 8.7% 10.1%
Global Dividend Trends Beta 41.8% 78.2% 70.3% 48.3% 38.4% 48.5%
Source: Credit Suisse Equity Derivatives Strategy
Since 2007, global dividends have increased with S&P, * Ratio of annual performance to annualized volatility

FTSE and Nikkei up 40%, 32% and 49% respectively

Interestingly, despite these headline events, as shown on
(Exhibit 1). Unique among global benchmarks, the SX5E
Exhibit 3, SX5E dividends volatility and beta in 2014 has
has seen its dividends fall 22% since 2007.
been lower than in most years since 2009. However,
Exhibit 1: Global Realized Dividends* perceptions have been different as Eurostoxx dividends
have also seen unwanted volatility in 2014 coming from
Cum Growth Cum Growth Since
2013 2014 YoY Growth since 2007 2010 Trough company-specific newsflow, two examples of which
SPX 34.5 39.4 14.2% 39.2% 91.6% include BNPs record fine (potential impact if BNP had
SX5E 109.8 114.1 3.9% -22.1% -1.6% cut 2015 dividends: 2 index points), and Totals Q4 2015
FTSE 235.4 233.5 -0.8% 31.7% 34.9% ex-div date announcement in March (a change in Q4
NKY 226.7 262.0 15.6% 49.1% 80.4% 2015s ex-div date knocked out 1.5 index points from
Source: Credit Suisse Equity Derivatives Strategy
* Perf and risk calculated from Dec to Dec expiries beta calculated using daily
2015 div futures value, with no clear impact on later
returns of SX5E and appropriate div future years). To make matters worse, European dividends have
a regional specific overhang due to structured product
Odd Man Out: SX5E Dividend Risk Profile issuance.
The exhibit below displays the risk/reward profile of SX5E Dividends and the Structured
European dividends since 2009. It draws a picture of
deteriorating performance for SX5E dividends for close Product Overhang
expiries compared to 2012 and 2013. This is most likely On top of the more obvious volatility repercussions, the
because dividends have been trading sideways on rise of the SX5E autocallable products (autocalls) in
disappointment regarding the absence of a significant European markets has also created a large dividend
ECB intervention in 2014. As shown on Exhibit 2, the overhang as investment banks became the largest natural
information ratio of dividends has been disappointing in buyers of dividends across maturities. More specifically,
2014 due to low performance, rather than higher risk. the dynamics of autocall products make the delta
exposure of investment bank trading desks more negative
Exhibit 2: SX5E Dividends Information Ratio Since 2009
when the SX5E index falls, and more positive when it
rises. However, while this delta typically would be hedged
using SX5E forwards with maturities of 1 year and longer,
the lack of liquidity in long-term forwards is forcing exotic
desks to go long short-term futures instead, making them
long SX5E implied dividends in the process (for more
information on this and the impact on forward pricing
please refer to our topical report: SX5E Forward Repo at
Distressed Prices Click here for full report). As the SX5E
falls and the expected duration of the autocalls increases,
so does the maturity of the resulting dividend exposure.

Source: Credit Suisse Equity Derivatives Strategy

* Perf and risk calculated from Dec to Dec expiries beta calculated using daily
returns of SX5E and appropriate div future

38
 EQUITY DERIVATIVES STRATEGY

Dividends impact (normal market conditions): As shown 2015/16 Earnings, Payouts And Dividends
on Exhibit 4, we calculate that on aggregate exotic desks
find themselves sellers of $30M worth of SX5E dividend Assuming stable payouts and growing company earnings,
futures, almost equally split between the front and the global dividends (ex Eurostoxx) are expected to post a
back of the dividend curve, for every 10 index point move. positive performance in 2015. S&P and Nikkei dividends
That is about $90M for every 1% price move in the SX5E are expected to rise ~30% over the next 5 years. SX5E
index. dividends, which are still between 1 and 5% below their
pre-December sell-off levels, are pricing-in a 12% fall
Exhibit 4: Expected Div Exposure vs SX5E Level over the next 5 years (vs a 5% fall in Dec 2013, i.e. an
even more negative outlook than in Dec 2013). This
shows the extent of the disaffection suffered by dividends
as we head into 2015.11
Exhibit 6: SX5E Dividends Information Ratio Since 2009

Source: Credit Suisse Equity Derivatives Strategy

* Cumulative growth since 2010

Dividends impact (market sell-offs): In a market pullback,

however, not all dividend exposure would (or could) be Source: Credit Suisse Equity Derivatives Strategy
hedged, and alternative dividend structures such as * Ratio of annual performance to annualized volatility
synthetic forwards (long a call/short a put) are often used.
However the mere size of this overhang is likely to cause Payouts: The payout ratio corresponds to the proportion
a large impact on dividend futures pricing. For example, in of company earnings that are paid out to shareholders.
a market sell-off similar to last years October pullback, up Companies are more likely to hold dividends steady as
to $1B worth of SX5E dividend futures would need to be earnings fall, and are slow to increase dividends when
sold on a market where average trading volume across profits initially rise, creating convexity in dividend
expiries reaches only about 20,000 contracts. During that payments versus earnings (Exhibit 7). Under our current
week, the SX5E dividend futures fell by almost double view of stable macroeconomic conditions, we expect
what had been expected based on their typical delta to payout ratios (around 30% on the S&P and 60% on the
the SX5E index (Exhibit 5). SX5E) to remain stable. As a result, the growth in
dividends should reflect the growth in underlying earnings.
Exhibit 5: SX5E Div Futures Moves In The October Sell-Off
Exhibit 7: Payout Ratio vs. Earnings Growth
SX5E Perf Beta Exp. Perf Actual Perf. Unexplained
DEDZ6 -10.9% 0.38 -4.1% -8.3% -4.2%
DEDZ7 -10.9% 0.51 -5.6% -9.8% -4.3%
DEDZ8 -10.9% 0.6 -6.5% -11.7% -5.2%
DEDZ9 -10.9% 0.65 -7.1% -12.3% -5.2%
DEDZ0 -10.9% 0.69 -7.5% -11.2% -3.6%
Source: Credit Suisse Equity Derivatives Strategy
* Cumulative growth since 2010

Opportunistic trading: Confronted with a deteriorating risk-

reward for simply going long and carrying short-term
dividends, anecdotal evidence suggests that dividend
traders have adjusted their tactics, taking profit from the
Source: Credit Suisse Equity Derivatives Strategy
apparent mean-reversion of 2015 dividend futures in
2014: going long futures when dividends were falling
closer to the 109/110 mark, and going short as they
were rebounding to close to their bottom up estimate of
113.

39
 EQUITY DERIVATIVES STRATEGY

Earnings: According to Credit Suisse Global Strategy, Exhibit 8: S&P and SX5E 2015 Dividend Scenarios
S&P earnings are expected to grow 8% in 2015, after S&P 2016 Divs Payout Ratio
growing 11% in 2013 and 8% in 2014. Earnings growth Earnings Growth 28% 30% 32%
is expected to be similarly strong in the Eurozone: 4% 40.77 43.68 46.59
company earnings should grow by 8%, helped by an 6% 41.55 44.52 47.49
improvement in profit margins; a weaker Euro against the 8% 42.34 45.36 48.38
dollar (a 10% decrease in the Euro could increase 10% 43.12 46.20 49.28
earnings by 10%); lower oil prices; and continued policy SX5E 2016 Divs Payout Ratio
accommodation from the ECB. Additionally: Earnings Growth 55% 60% 65%
Strong earnings forecasts are not solely the 6% 108.63 118.51 128.38
consequence of strong top line assumptions, and 8% 110.68 120.74 130.81
consensus seems to underestimate the potential 10% 112.73 122.98 133.23
for strong GDP growth both in Europe and the 12% 114.78 125.22 135.65
Source: Credit Suisse Equity Derivatives Strategy
US
US profit margins are unlikely to fall as US wage
growth should be contained until unemployment Dividend Impact of Europe Deflation
falls below full employment levels (5.4%)
Dividends are often referred to as an inflation hedge, which
A strong proportion of recent margin progression on top of structured products impact helps explain the
comes from lower interest charges, which is downward sloping SX5E dividend term structure. The
expected to continue in the us and potentially SX5E dividend term structure would therefore be expected
improve in Europe to steepen should newsflow confirm fears that the
Dividends: Our outlook for 2015 global dividends is Eurozone is on the verge of deflation and in particular if QE
therefore as follows: is announced by the ECB in Q1 2015.
Nikkei just happens to provide a text case of what the
S&P: 2015 dividends, currently priced 6.6%
impact could be. While Nikkei and SX5E dividend term
above 2014 levels, appear fairly priced versus
structures have been very closely correlated between 2010
2014 earnings growth of 8% (assuming like-for- and 2012 as both markets share similar characteristics, in
like dividend growth, 2015 would price in a 1.4% particular having a large market for autocall products. In
risk premium). Based on scenarios on Exhibit 8, December 2013, after QE was announced together with
we calculate that dividends paid out in 2016 the other arrows of Japanese premier Shinzo Abe, Nikkei
could represent 45.4 ips, or 2 ips higher than and SX5E have decoupled, with at some point Nikkei 5Y
current 2016 div swap rates. dividends trading 15% higher than 3Y.
SX5E: 2015 dividends are expected to reach
However, the impact of QE on SX5E dividends is expected
113.3 based on a bottom up aggregation of
to be only a fraction of what it has been on Nikkei
analyst forecasts, or 112 on a more conservative
because:
estimate, versus current dividend future of 111.8
leaving hardly any upside. With a stable payout The SX5E dividend market is considerably more liquid
ratio and an 8% growth in earnings for 2014, we than that of the Nikkei,
estimate 2016 dividends of EUR 120.7, lower The high dividend yield of the SX5E (3.5%) restricts
than the aggregation of analysts forecasts (as the possibility of a strong performance of its long-term
high as 129ips). This suggests almost 9% upside dividends that would not be mirrored in the SX5E
versus current futures prices, and compares index itself (it may therefore be preferable to just go
reasonably well versus downside mark-to-market long SX5E). The Nikkeis dividend yield is only 1.5%.
risk: for comparison, the most 2015 dividends fell Should we see large upside on SX5E, a lot of SX5E
this year was 3.5% when the SX5E index lost autocalls will knock out, making Exotic trading desks
sellers of SX5E long term dividends
11% in October.

40
 EQUITY DERIVATIVES STRATEGY

Variance Trading Outlook

Given the asynchronicity in global economic cycles, we Exhibit 2: Historical Comp. Of Average Of Spreads
expect to see an increase in index level relative value
variance spreads. Extrapolating from trends in 2014 as
discussed in our report Variance Spreads And The
Variance Risk Premium (Click Here For Full Report), such
variance spread trades will likely have the following
characteristics:

The underlying of the long variance swap will have a

high beta to global equities (SX5E, HSCEI, Russell)
Liquid, with possible clip sizes of up to $500k vega
The implied skew of the long is structurally flat due to
a thriving structured retail product market selling
Source: Credit Suisse Equity Derivatives Strategy
equity volatility to generate yield (Nikkei, Kospi, * Cumulative growth since 2010
HSCEI and lately SX5E). (A structurally flat skew of
the long helps during market corrections, as the ATM Is Short Variance a Crowded Trade?
implied volatility of the long tends to increase less
than that of the short.) Given the popularity of short variance trades last year,
concerns have arisen as to whether it is becoming a
While the majority of spread trades continue to be crowded trade. Indeed, given that 5 out of 6 spreads
implemented using vanilla variance, interest has been involve a short S&P variance leg, risk limits are already
developing for elaborate structures such as close to being reached by volatility arbitrage funds, and
we expect:
Forward starting variance spreads for SX5E/S&P
(due to the relatively steeper term structure of S&P More S&P variance volume: as the only way to
variance), implement new spreads when an opportunity arises
Exotic structures: corridor variance, Min vs Max is to close an existing spread
variance (please call for more details), where the Shift towards shorting alternate, less liquid index leg:
underlying (typically Nikkei/S&P variance spread) i.e. (SX5E/FTSE)
was trading at less interesting levels
Past distribution of the implied and realized 2Y spreads for
Exhibit 1: Popular Variance Spreads in 2014 the var spreads listed in Exhibit 1 are provided in Exhibit
Avg Avg Clip Size
3, with key levels. For instance, entering the SX5E/SPX
Beta of Beta of Skew of Skew of (USD 2Y var spread when the entry level is below 1.1%, should
Long/Short Long Short Long Short Vega) yield positive P&L 80% of the time based on past realized
Nikkei/S&P 0.91 0.92 0.9% 7.6% 750k spread distribution.
SX5E/S&P 1.09 0.92 4.6% 7.6% 1mio
HSCEI/S&P 1.09 0.92 0.7% 7.6% 500k
Exhibit 3: Key Levels For Popular Variance Spreads (2Y Tenor)
KOSPI/S&P 0.8 0.92 1.7% 7.6% 500k
SX5E/FTSE 1.09 0.87 4.6% 5.8% 500k NKY/SPX SX5E/SPX HSCEI/SPX KOSPI/SPX SX5E/FTSE RUT/SPX
Russell/S&P 1.11 0.92 6.8% 7.6% 500k Implied Spread
Last 4.9% 2.4% 9.2% 0.4% 3.6% 4.9%
Source: Credit Suisse Equity Derivatives Strategy
* Cumulative growth since 2010 Average Level (2014) 5.4% 2.0% 7.7% 1.0% 3.3% 5.2%
Min Level (2014) 1.0% -0.4% 5.0% -1.9% 2.3% 3.4%
Average Level (2004-2014) 2.1% 2.6% 9.9% 2.4% 2.9% 6.4%
If we exclude extreme observations in 2010, on average Min Level (2004-2014) -6.1% -4.6% -2.6% -12.3% -1.5% 2.8%
those spreads have been trading near decade lows Key Level (20th Percentile of
Realised Spread) 2.0% 1.1% 8.5% 0.6% 2.0% 4.7%
during the October and December sell-offs (Exhibit 2). Realised Spread
Investors trading in and out of those spreads around Last 2 Years 12.7% 5.4% 8.8% 1.1% 5.0% 4.4%
Average Level (2004-2014) 5.2% 3.4% 14.9% 4.4% 4.0% 6.2%
those periods have been implicitly trading around equity Min Level (2004-2014) -0.4% -1.9% 5.3% -3.1% -0.2% 1.4%
market performance rather than pure volatility. Implied as a Percentrank of Realised
Last 45.2% 35.0% 36.5% 18.0% 45.0% 21.8%
Average Level 2014 48.3% 29.0% 10.6% 23.8% 43.2% 24.3%
Min Level 2014 2.6% 14.0% 0.0% 4.1% 31.3% 3.2%
Source: Credit Suisse Equity Derivatives Strategy
* Cumulative growth since 2010

41
 EQUITY DERIVATIVES STRATEGY

SX5E vs SPX Variance: Too VSTOXX Liquidity Update

Crowded? 5 and 4 years after their respective launch by Eurex,
Although it is still the most evident trade to receive the liquidity of the VSTOXX futures and options
exposure to SX5E volatility and skew, the SX5E/S&P markets continues to improve as total open interest
variance spread is now trading significantly above fair value (futures and options) increased by about 17% year-on-
due to its extensive popularity over the last couple of years. year (Exhibit 65). While futures open interest has been
We calculate that the SX5E 3Y variance now trades up to flat (roughly EUR20M vega in open interest across
2 volatility points above its static, vanilla option replication. expiries), options open interest gained more than 50%,
On the other side, the S&P 3Y variance trades circa 1 from EUR9M to EUR14M vega. Volume traded have
volatility point below its static replication. increased for both futures and options contracts, by
32% and 56% respectively.
As shown on Exhibit 4, while the 3Y 80% vanilla volatility
spread is now trading close to its lows (1st percentile of all The greater liquidity in VSTOXX derivatives has been
observations since 2001), the variance swap trade trades partly driven by the CBOE decision last June to extend
circa 3 volatility points above, in its 15th percentile. Please trading in VIX futures to 24 hours. Indeed, one of the
call for more details. most popular uses for VSTOXX derivatives is as a
Exhibit 4: SX5E/S&P 3Y Variance vs 3Y, 80% Vanilla Spread
relative trade versus the VIX.
12% However, the VSTOXX derivatives market still
Var Spread
represents only a fraction of the size of the VIX
10%
markets. Combined open interest for futures and
8% Vanilla Spread (20% OTM) options is about 17 times lower than for VIX in dollar
6% terms. This is due to a general preference by European
4%
investors for OTC products versus listed, the absence
of structured investment strategies benchmarked on
2%
the VSTOXX, a more pronounced concentration of
0% equity holdings in the US, but also simply to the smaller
-2% size of the volatility market in Europe. With potential QE
in Europe in early 2015, SX5E could come back on
-4%
U.S. investors radar and the liquidity of VSTOXX
-6% derivatives is therefore expected to continue improving.
Source: Credit Suisse Equity Derivatives Strategy

Exhibit 65: Open Interest Across V2X Derivatives (EURmio) *

60

50
V2X Options
40 V2X Futures

30

20

10

0
Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14

Source: Credit Suisse Equity Derivatives Strategy

* Option figures makes the simplifying assumption of a 50% delta to VSTOXX

42
 EQUITY DERIVATIVES STRATEGY

Trade Recommendations for 2015

43
 EQUITY DERIVATIVES STRATEGY

Top Macro Hedges

Russia Default Risk: Buy RSX Downside
Bearish Euro With FXE Put Spread Collar

Russia Hedge: Buy RSX Jan16 12-Strike Put

As we enter 2015, what started initially as a currency crisis for Russia has turned into full blown economic and credit crises as
well. The big risk for equity investors is that this will lead to a 1998-style debt default (see pg 7-9 for details). As a tail hedge,
we recommend going long a deep OTM put on RSX (Russia Equity ETF). Since term structure is inverted (Exhibit 1), we like
buying the Jan16 12-strike put for $1.70 (spot ref 14.79). The strike is 19% OTM while the trade has an initial delta of
27%. Even though implied volatility is currently extremely elevated, it looks underpriced when compared to other asset
classes (FX and credit). E.g. RSX 1M implied vol, at 72%, is still far below the 2008-peak of 169%, while USDRUB 1M
implied vol is already double its 2008-high (see Exhibit 2).
*** Risks: The risk to buying a put is limited to the premium paid. ***
Exhibit 1: RSX Term Structure is Inverted Exhibit 2: Equity Vol May Be Underpriced vs. FX
75 180 90

70 160 RSX 1M Implied Vol (Left Axis) 80

RSX Term Structure
65 140 USDRUB 1M Implied Vol (Right Axis) 70
Implied Volatility (%)

120 60
Implied Vol (%)
60
100 50
55
80 40
50
60 30
45
40 20
40
20 10
35
0 0
1M 2M 3M 6M 1Y 18M
Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15
Source: Credit Suisse Equity Derivatives Strategy

Euro Breakup Hedge: Buy FXE Jan16 115-105 Put Spread Funded by the 125-Call
2015 starts with a Greek election (Jan 25th) and ends with a Spanish election (most likely Oct-Nov). With the incredible rise
in popularity of Eurosceptic parties in recent years, we believe investors may be underpricing the risk of a euro breakup (see
pg 10-11 for details). As a tail hedge, we recommend buying put spread collars on FXE (Euro Currency ETF) to take
advantage of the current steep skew and high vol environment (see Exhibit 3). We feel comfortable selling the upside given
structural reasons for euro weakness this year: namely, expected policy divergence between the ECB and Fed. Specifically,
we like buying the FXE Jan16 115-105 put spread and selling the 125 call for $0.85 in net premium (spot ref 118.20).
Downside protection goes from -2.7% to -11.2% from current spot while the upside strike is more than 5.7% away.
*** Risks: The risk to buying a put spread is limited to the premium paid. The risk to selling an uncovered call is unlimited ***
Exhibit 3: FXE 1Y Skew Has Steepened to 1-Year High Exhibit 4: Option Trade Payoff Diagram at Expiry
1.8
FXE 1 Year Skew (25-Delta)
1.6

1.4
Skew (%)

1.2

0.8

0.6

0.4
Jan-14 Mar-14 May-14 Jul-14 Sep-14 Nov-14 Jan-15

Source: Credit Suisse Equity Derivatives Strategy

44
 EQUITY DERIVATIVES STRATEGY

Top Cross-Asset Hedge

SPX ATM Put Contingent on 5Y Swap Rate Rising Above 3%
Opportunity: Protect Against Rate Shock as Fed Gets Set to Hike
Interest rate risk has consistently been the biggest driver of equity volatility in recent years (see Exhibit 1). In 2014, a
collapse in bond yields in October caused the biggest increase in equity vol in over 3 years, with the VIX jumping to an
intraday high of 31%.
As we look ahead to 2015, contagion risk remains high, especially as the Fed gets set to hike rates for the first time in
almost a decade. While the rate market is currently pricing for a September hike (Exhibit 2), CS economists believe it
could come in June. The risk is that an abrupt move higher in rates caused by an earlier-than-expected hike will then
spill over into equities.
Moreover, our Rate Strategy team highlights that the bond market has become more fragile in recent years and any
volatility could be exacerbated by poor liquidity. Lower risk taking capacity on the part of dealers means they are less
able to step in as an intermediating buffer during times of stress. As a result, there is more likelihood for outsized
moves in the bond market, as we saw last October. See pg 11-12 for details.

Exhibit 1: Volatility Contagion Btw Rates & Equities Exhibit 2: Fed Fund Futures are Pricing for Sep Hike
80%
Taper Tantrum
70%

60%
Volatility Spillover

Oct'14 Sell-off
50%

40%

30%
SPX vs. 10Y Treasury Yield (1M)
20%
Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 Jul-14 Oct-14

Source: Credit Suisse Equity Derivatives Strategy Source: Credit Suisse Equity Derivatives Strategy

Derivatives Strategy Idea

Trade: Buy SPX 9M ATM Put Contingent on the 5-Year Swap Rate Rising to Above 3%
For investors concerned about an abrupt move higher in rates driving equities lower, we recommend buying a 9-month ATM put
on the S&P contingent on the US 5-year swap rate rising to above 3% at expiry for 1.0% of notional (SPX ref at 2060.14, 5Y
forward ref at 2.1617%). The trade takes advantage of the currently elevated levels of correlation between the two assets (see
Exhibit 3). The contingent put represents an 85% saving compared to the vanilla ATM put, which costs 6.5%.
*** Risks: The risk to buying a conditional put option is limited to the premium paid.***

Exhibit 3: 9M Rolling Correlation Between S&P and 5Y Swap Rate

50%

40%

30%
Correlation

20%

10%
SPX- 5Y Swap Rate Correlation (9M)

0%

-10%
Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 Jul-14 Oct-14 Jan-15
Source: Credit Suisse Equity Derivatives Strategy
45
 EQUITY DERIVATIVES STRATEGY

Top Sector Volatility Trades

Buy Energy Volatility; Sell Crude Oil Volatility
Sell Technology Volatility

ENERGY SECTOR: Buy XLE 1Y implied volatility and sell USO (oil) 1Y implied volatility
Implied volatility for the energy sector currently stands at 23%. Despite these seemingly elevated levels, XLE one year
implied volatility reached highs of 40% in 2011 and the sector realized 24% volatility in 2H 2014 and 30% volatility in
4Q 2014. We think volatility could still move higher as there are many catalysts yet to come. In 2015, the longer-term
consequences of lower oil prices will begin to play out, potentially including but not limited to M&A, liquidity issues,
restructuring, and capital allocation decisions. These should result in clear winners and losers and keep energy stocks
on the move even after oil prices settle down. However, we recommend using a short USO volatility position as a hedge
in case oil markets settle and dampen energy volatility more than expected. At 41%, USO vol is trading at an all-time
high versus XLE vol, making the trade attractive on a relative basis as well. This trade can be implemented via delta
hedged at-the-money-straddles or variance swaps.
***The risk to selling a variance swap or straddle could be unlimited. The risk to buying a variance swap is that variance could go to zero. The risk to buying a
straddle is limited to premium paid.

Exhibit 1: USO / XLE implied vol spread at all-time highs Exhibit 2: History suggests XLE vol still has room to move
higher

Source: Credit Suisse Equity Derivatives Strategy

Source: Credit Suisse Equity Derivatives Strategy

TECHNOLOGY SECTOR: Sell XLK 1Y implied volatility

Despite its strong fundamental outlook, Technology Exhibit 3: Technology implied vol elevated in 97th percentile and
one-year implied volatility currently stands in the significantly above realized
97th percentile at 19%. Tech implied vol is the
fourth highest of the ten major sectors, though it
has realized the second-to-lowest volatility of the
sectors in each of the past two years. Additionally,
the spread between one-year implied volatility and
one-year realized volatility is near two-year highs
and is more than one standard deviation above its
mean on a one-, three-, and five-year basis. We
expect that the sectors strong growth prospects,
low financial leverage, and compelling valuation will
help keep Tech vol contained. This trade can be
implemented via delta hedged at-the-money-
straddles or variance swaps.
Source: Credit Suisse Equity Derivatives Strategy
***The risk to selling a variance swap or straddle could be unlimited.

46
 EQUITY DERIVATIVES STRATEGY

Top Thematic Energy Trades

Buy XLE Trough with Recovery
Buy USO Limited Recovery

ENERGY SECTOR: Buy XLE 1Y ATM down-and-in call

Our Energy Teams 2015 Outlook calls for oil prices to Exhibit 1: XLE spot versus knock-in price and rebound
trough during 1Q15 followed by a recovery throughout breakeven price
the remainder of the year, normalizing at a price higher
than current spot. For investors who believe that Energy
stocks will follow a similar trajectory, we recommend the
purchase of a one year at-the-money down-and-in call
on XLE. With this structure, investors are long an ATM
XLE call that only becomes active (i.e. knocks in) if
XLE declines at least 10% in first three months (daily
observations). If XLE does not reach the knock-in
price within the prescribed timeframe, the option expires
worthless. This option currently costs 2.36% of spot
(ref $79.53), representing a 73% discount to a 1Y
vanilla ATM call. Using current spot price of $79.53,
the trade is only profitable if XLE declines to at least
Source: Credit Suisse Equity Derivatives Strategy
$71.58 within the first three months, followed by a
rebound to at least $81.41 by the 1Y expiry.
***The risk to buying a down-and-in call is losing premium paid.

ENERGY SECTOR: Buy USO 1Y ATM up-and-out call

A key tenet of our Energy Teams 2015 Outlook is Exhibit 2: USO spot versus knock-out price and breakeven
that oil prices will normalize at a price higher than price
current spot but fall far short of average levels
seen over the last five years. For investors who
believe oil will recover, but only a portion of its
losses of the last three months, we recommend
the purchase of a one year at-the-money up-and-
out-call. With this structure, investors are long an
ATM call that loses all value (i.e. knocks out) if
USO increases 30% or more over the 1Y expiry
(daily observations). This option currently costs
1.75% of spot, representing an 89% discount to a
1Y vanilla ATM call. Using current spot price of
$19.89, the trade is only profitable if USO trades
above $20.23 but no higher than $25.86.
*The risk to buying an up-and-out call is losing premium paid. Source: Credit Suisse Equity Derivatives Strategy

47
 EQUITY DERIVATIVES STRATEGY

Yield Enhancement: Short Index Straddles

Sell Expensive 1-Year Implied Volatility

Opportunity: Capture rich volatility premium by selling 1-year straddles

1-Year Implied Vol in the 96th Percentile High: Volatility has picked up significantly in recent weeks as macro fears
have weighed on the market. S&P 1Y implied vol has risen to over 17% while FTSE 1Y implied is at 16% - both are in
the 96th percentile highs over the past year. See Exhibit 1.
Limited Upside in the Market: CS Global Equity Strategy team sees a more subdued rally this year, especially for the
S&P, where they have a year-end target of 2200 (+7%). They see a strong first half of the year followed by a
correction in the second half for the following reasons:
o Valuation: Equities look abnormally cheap against the other major asset clases
o Positioning: The corporate sector has been the only significant buyer of equities this year and we believe it has
enough fire power to buy another $1.6 trillion. Pension funds are still underweight US equities and increased
retail and institutional buying should be supportive of the S&P.
o Earnings: The most recent earnings season was strong, top line assumptions for this year are cautious and
margins outside the US are not extended.
o Fed Policy: We expect the Fed to raise rates in June and historically, the S&P has tended to see a correction
after the first hike.
Attractive Yields and Break-Evens: As a result, for investors who believe that market upside is likely limited this year
and want to generate additional yield, we recommend selling 1-year straddles at our year-end targets to take advantage
of rich long-dated implied volatility. For the S&P, this would generate 13.3% in premiums with a large breakeven range
of -6.4% and +20.2% (see Exhibit 2).

Exhibit 1: SPX & FTSE 1Y Implied Vols at 96th %tile High Exhibit 2: SPX Trade Payoff Diagram

17.50%

15.00%

12.50%
Jun-13 Dec-13 Jul-14 Dec-14
S&P FTSE
Source: Credit Suisse Equity Derivatives Strategy
Source: Credit Suisse Equity Derivatives Strategy

Derivatives Strategy Idea

Trade: Sell Dec15 SPX 2200 Straddle or FTSE 7300 Straddle
We suggest selling Dec15 straddles centered on Credit Suisses price targets for the S&P and FTSE. The premiums generated
are indicatively 13% for the SPX to 16% on the SX5E (Exhibit 3). The trades are expected to yield positive P&L as long as the
indices do not decrease by more than 4-5% and do not appreciate by more than 20-28% (see table below).
*** Risks: The risk to selling a straddle is unlimited.***

Exhibit 3: Short Straddles Summary

Source: Credit Suisse Equity Derivatives Strategy

48
 EQUITY DERIVATIVES STRATEGY

Europe Outperformance Over US

Play Europe Catch-Up with SX5E/SPX Outperformance Option

Opportunity: Monetary policy divergence should drive Eurostoxx outperformance

Credit Suisse Global Equity Strategy team believes that the SX5E will outperform the SPX in 2015, particularly in the
first half. They have mid-year target returns of +18% for SX5E vs. +9% for SPX for the following reasons:
o Monetary policy divergence: While the US is set to hike rates for the first time in almost a decade, we expect
Draghi to announce full-scale QE at the January ECB meeting or at the latest, by the March meeting.
Historically, the US has underperformed by an averaged 8% in the six months prior to the first Fed hike.
o Strong dollar: The US dollar has entered a secular bull market and we expect it to further strengthen against
the euro. This will be a positive for European equities: we estimate that every 10% lower in the euro adds 8%
to earnings. Conversely, a strong dollar will be a headwind for US companies.
o Record SX5E underperformance: Eurostoxx lagged the S&P by an additional 10% in 2014, bringing the
total underperformance to about 100% in the past 6 years.
The option is short SX5E/SPX implied correlation, which is currently trading at an elevated 78%. We expect correlation
to break down this year given the divergence in monetary policy.

Exhibit 1: SX5E vs. SPX Performance Exhibit 2: SX5E/SPX 12M Historic Rolling Correlation

100%

90%

80%

70%

60%

50%
1999 2001 2003 2005 2007 2009 2011 2013

12m Rolling Correlation Current Implied Correlation

Source: Credit Suisse Equity Derivatives Strategy

Source: Credit Suisse Equity Derivatives Strategy

Derivatives Strategy Idea

Trade: Buy Jun15 ATM SX5E vs. SPX Outperformance conditional on SPX > 2100 for 1.4%
The trade is particularly suited to investors who are long S&P and who would like to benefit from European exposure with little
risk, since the trade would make them long the best performer of the two, at the cost of only 1.4% of notional. The June maturity
captures both QE announcement by the ECB (expected January) and the Feds first rate hike (CS forecast is June).

Without the S&P conditionality, the vanilla outperformance option would cost 3.1%. See table below for pricing details.

*** Risks: The risk to buying an outperformance option is limited to the premium paid.***

Exhibit 3: Indicative prices for conditional outperformance

Delta Vega
Option Premium SX5E S&P SX5E S&P
Vanilla Outperformance 3.05% 44.21% -46.05% 0.17% 0.03%
Conditional S&P > 2100 1.41% 24.15% -12.53% 0.20% -0.12%
Conditional S&P > 2200 0.94% 15.92% -3.56% 0.16% -0.07%
Source: Credit Suisse Equity Derivatives Strategy

49
 EQUITY DERIVATIVES STRATEGY

Long SX5E & SX7E Call Spreads

Position For QE Announcement With Levered Delta On SX5E And SX7E

Fundamental: CS Global Equity Strategy is overweight SX5E with a mid-year target price of 3700 (18% upside):
More supportive external environment: Credit Suisse expects a substantial and sustained decline in the euro in
2015 due to the combination of progressively rising US policy rates and negative ECB deposit rate. Every 10%
lower in the Euro adds 0.3% to Eurozone GDP and 8% to European earnings. Lower Oil prices also help: 10%
lower in oil prices is 0.2% more in Eurozone GDP. This is in deep contrast with market indicators which, according
to Global Strategy, price-in a GDP contraction of 0.5% to 1% - which would represent the deepest recession
since 2009.
Full-blown QE could be announced as soon as of the next ECB meeting on 22 Jan. Our Global Equity Strategy
team expects the ECB to pursue sovereign QE and that it will be effective in achieving a re-rating of risky assets,
with as much as 650bn of extra bond buying (7% of GDP) required to expand the balance sheet by 1trn over
the next 2 years.

Trade Analysis: Go Long SX5E Jun 2850/3200/3600 Call Spread Collar for zero-cost (ref. 3139), 61d
Room for potential rally: The call spread allows to benefit from SX5E upside starting only 2% above spot, up to
3600 (year-end target price).
Comfortable downside buffer: The put is struck at 2850, i.e. immediately below the SX5E sell-off lows on 16
October. The put strike offers a large protection buffer (9%) against political risk in Europe (elections in Greece,
Portugal and Spain, and the Ukraine crisis) when Global Strategy believes that most risks are already priced-in.
Downside skew is steep (2850 put vol at 24.2%) due to Greece elections, making the deep out-of-the-money
put interesting to go short. Upside skew is relatively flat (3600 call vol at 18%) due to 1) positioning ahead of next
ECB meeting, and 2) marginal impact from structured retail products, making the call spread attractive.

Alternative Trade: Go Long SX7E 145/160 Jun Call Spread for 3.6 or 2.6% (ref. 136), 18d, 4.2x leverage
Fundamental: CS Global Equity Strategy is overweight on European banks: 1) they are expected to be among the
main beneficiaries of full-scale QE; 2) More transparency following the AQR stress test; 3) Earnings revisions are
better than the markets; 4) Development of securitization market in Europe with the involvement of the ECB.
Trade Analysis: At 29%, SX7E 6M ATM implied volatility does not appear too expensive despite recent increase,
while the flat upside skew (the Jun160 call trades at 28 vol) translates into an interesting leverage of 4.2x at
maturity. We would avoid going short put to finance the call spread given the risk of sell-off in Peripheral banks in
case of Grexit.

Exhibit 1: SX5E & SX7E 6M Implied Volatilities Exhibit 2: Trades Summary

SX5E SX7E
30.00% Strategy Call Spread Collar Call Spread
Ref 3139 136.2
Strikes 2850 / 3200 / 3600 145 / 160
25.00% Premium -3.3 3.6
Premium (%) -0.1% 2.6%
Jun-15 ATM Vol 21.1% 29.1%
20.00% Delta 61% 18%
Source: Credit Suisse Equity Derivatives Strategy, as at date 2 Jan 2015

15.00%
Jun-13 Dec-13 Jul-14 Dec-14
SX5E SX7E
Source: Credit Suisse Equity Derivatives Strategy

50
 EQUITY DERIVATIVES STRATEGY

Long SX5E/Short S&P Forward Variance Spread

Replace Spot Variance Spreads With Forward Starting Structures

Fundamentals: SX5E/S&P variance spread has been one of the most popular variance spread trades in 2014:
Superior risk-reward: SX5E/S&P var spread benefits from 1) a strong correlation between both underlyings, 2)
a larger beta of the long (1.2 for SX5E versus 0.9 for the S&P), and 3) a systematically depressed volatility and
volatility skew on the long leg (SX5E) due to structured product offering. All three characteristics were listed as
forming the basis of superior variance spread risk rewards in our research Variance Spreads and the Variance Risk
Premium (Click here for the full report).
Interesting entry point: SX5E/S&P variance spread benefits from its implicit long vol exposure and has traded at
favorable levels throughout 2014 due to low volatility. Additionally, the recent flattening of the SX5E volatility term
structure in the long maturities has coincided with a steepening in the S&P, pushing the spread between 5Y/2Y
SX5E vol and 5Y/2Y S&P vol to near all-time lows (Exhibit 1). This in turn has pushed the 2Y/5Y forward starting
variance spread near all-time lows, and at interesting levels compared to the past distribution of the 3Y spot
variance spread (Exhibit 2).
Exhibit 1: SX5E Minus S&P 5Y/2Y Implied Volatility Spread Exhibit 2: SX5E/SPX 2Y/5Y Fwd Variance Spread vs 3Y
3% Spot Spread
14%
2%
SX5E/S&P Fwd Var 2Y/5Y
12%
1% Spot Var Spread
10%
Last Fwd Var
8%
0%
1998 2000 2002 2004 2006 2008 2010 2012 2014 6%
-1%
4%

-2% 2%
0%
-3% 2001 2003 2005 2007 2009 2011 2013
-2%
-4% -4%

Source: Credit Suisse Equity Derivatives Strategy -6%

Source: Credit Suisse Equity Derivatives Strategy

Trade Analysis: Go Long SX5E/Short S&P Dec16/Dec19 Forward Variance Spread at -0.8%
A substitute for SX5E/S&P spot variance spread: with Dec15 spot variance now trading close to 5% (its
highest level since 2011, Exhibit 3), when the trade was typically entered at close to 2 volatility points earlier in the
year, we suggest to take profit on the spot spread and free up risk budgets to enter the forward-starting spread.
Superior backtest: currently offered at -0.8%, the SX5E/S&P Dec16/Dec19 forward variance spread currently
trades in the bottom 1% of all observations of the SX5E/S&P spot variance spread since 2001. We calculate that
2Y/5Y Forward Variance Spreads entered at current levels and unwound on variance swaps start date, would
have yielded a positive P&L 98% of the time, with an average P&L of 3.2x initial vega (Exhibit 4)
Mark-to-market: As discussed in our report The Mighty SX5E Autocall Market (), the traditionally negative
correlation of the spread to Equity markets, has become positive in 2014. We would expect to post positive mark-
to-market P&L in the event of a strong SX5E in 2015.
Exhibit 3: SX5E/S&P 1Y Variance Spread Exhibit 4: Backtest Of 5Y/2Y SX5E/S&P Fwd Var Spread (1
10% vega)
20
8%
15
6%

10
4%

2% 5

0% 0
2009 2010 2011 2012 2013 2014 2001 2003 2005 2007 2009 2011 2013
-2% -5

-4%
-10
Source: Credit Suisse Equity Derivatives Strategy Source: Credit Suisse Equity Derivatives Strategy

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 EQUITY DERIVATIVES STRATEGY

Long SX5E Dividend Call Ratios

Upside Exposure To SX5E Divs Without The Mark-To-Market Swings

Fundamental: SX5E dividends could benefit from a rebound in Eurozone earnings in 2015 and 2016. However as shown by
Q4 2014s experience going long outright dividend futures carries large mark-to-market risk.
Up to 20% upside in 2017 earnings vs 2015: Credit Suisse Equity Strategy expects a 8.2% and 10.9% rebound in
Eurozone earnings in 2015 and 2016, respectively, thanks to 1) a pickup in GDP growth to 1.7% in 2016, and 2) a
weaker Euro.
2017 Dividends between 120 and 135: assuming stable payouts, 2017 dividends could grow to 135ips from an
expected 113ips in 2015. However, due to stock-specific risks (Spanish banks, Oil producers, German Utilities dividends
contribute 25ips to the index dividend, and are fragile due to regulatory pressure, and low oil prices, respectively), and
given that payout ratios could converge down from their current 60% level, a more realistic estimate would put 2017
dividends somewhere between 125 and 130. This compares to a current 107.5 handle for 2017 dividend futures.
Large mark-to-market risk. as discussed on page 42, SX5E dividends suffered two successive sell-offs in October
and December as structured trading desks had to dump up to $1bn notional of dividend futures in an attempt to re-
hedge their increasing short SX5E forward position. This situation is expected to reproduce in the event of further SX5E
weakness.
Full-blown QE could be announced as soon as at the next ECB meeting on 22 January. A similar announcement by the
Bank of Japan in December 2012 resulted in a significant steepening of the Nikkei dividend term structure. However any
steepening of the SX5E dividend term structure is expected to be of a limited scale due to the SX5Es large dividend
yield (3.5%) and the larger liquidity of SX5E dividends compared to that of the Nikkei.
Trade Analysis: Go Long SX5E 2017 Dividends 110/120 1x2 Call Ratios for 0.8 (ref. 104), dividend delta -12d
Positive P&L between 110.8 and 129.2 ips: as shown on Exhibit 112, the trade will break even if the SX5E pays
between 110.8 and 129.2 ips in 2017. P&L will culminate at 9.2 (11.5x leverage) should SX5E dividends realize 120 in
2017. Losses will be limited to the premium paid if dividends realise below 110, however losses will accrue on a 1:1
basis should dividends realized over 129.2.
Limited exposure to market drawdowns: as shown on Exhibit 113, the trade should be insensitive to the 2017
implied dividend moves, provided that SX5E implied dividends stay below 110ips (current dividend delta of -10d), taking
down the mark-to-market risk of another dividend sell-off to virtually zero.
Short dividend volatility: with a vega of -0.41 per option, the 1x2 call ratio goes short dividend volatility at 14%, a high
level compared to the typical volatility of circa 10% due to recent market performance. Implied volatility is expected to
gradually come down as 2017 dividends lose part of their beta (see our report . For comparison, 2016 dividend implied
volatility is currently 10% only.
Risk is an early rally in dividends: the trades negative delta will cause a mark-to-market loss in the event of a rally in
2017 dividends early in 2015. However as shown on Exhibit 113, this loss is expected to turn into a gain going into
year-end, provided that 2017 implied dividends stay below 120 in 2015.
Exhibit 112: Payoff diagram at expiration Exhibit 113: 1x2 Call Ration P&L Profile At Diff. Times Of The Trade
10 10
8 Now
8
6 In Dec15
6
M2M P&L (inc. premium paid)
P&L (inc. premium paid)

4 At Expiry
4
2 2
0 0
100 110 120 130 140 90 100 110 120 130
-2 -2
-4 -4
-6 -6
-8 -8
-10 -10
2017 Dividends (ips) 2017 Dividends (ips)
Source: Credit Suisse Equity Derivatives Strategy Source: Credit Suisse Equity Derivatives Strategy

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 EQUITY DERIVATIVES STRATEGY

Credit Suisse Equity Derivatives (US)

James Masserio
Head, US Equity Derivatives
+1 212 325 5988
[email protected]

Credit Suisse Equity Derivatives Strategy and Structuring

Grace Koo Edward K. Tom

Head, Equity Product Strategies Head, Equity Derivatives Strategy
+1 212 325 4755 +1 212 325 3584
[email protected] [email protected]

Credit Suisse Equity Derivatives Sales

Tim Scanlon Elaine Sam

Head, Equity Derivatives Sales Head, Structured Retail Products
+1 212 325 4755 +1 212 325 5909
[email protected] [email protected]

Credit Suisse Equity Derivatives Trading

Khoa Le Rishabh Bhandari

Head, Equity Derivatives Flow Trading Head, Equity Derivatives Structured Trading
+1 212 325 8734 +1 212 325 7281
[email protected] [email protected]

Credit Suisse Equity Derivatives (Europe)

Walter Rotondo
Head, EMEA Equity Derivatives

Credit Suisse Equity Derivatives Strategy

Stanislas Bourgois
+44 207 888 0459
[email protected]

Credit Suisse Equity Derivatives Sales

Andrea Negri Manish Vekaria

+44 207 888 7081 +44 207 883 7010
[email protected] [email protected]

Credit Suisse Equity Derivatives Trading

Jonathan Bigmore
+44 207 888 0117
[email protected]

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 EQUITY DERIVATIVES STRATEGY

Credit Suisse Trading and Derivatives Strategy

Edward K. Tom
Managing Director

Equity Derivatives Strategy (EMEA) Equity Derivatives Strategy (US)

Stanislas Bourgois Edward K. Tom

Head, Equity Derivatives Strategy EMEA Head, Equity Trading and Derivatives Strategy
+44 207 888 0459 +1 212 325 3584
[email protected] [email protected]

Index Analytics (Global) Trading Strategy (EMEA)

Colin Goldin Mark Buchanan

Head, Index Analytics (Global) Head, Trading Strategy EMEA
+44 207 888 9637 +44 207 888 0908
[email protected] [email protected]

Market Structure Strategy Delta-One Strategy

Ana Avramovic Victor Lin

Director Director
+1 212 325 2438 +1 415 836 7643
[email protected] [email protected]

Disclaimer:
This material has been prepared by individual traders or sales personnel of Credit Suisse Securities Limited and not by the Credit Suisse research department.
It is provided for informational purposes, is intended for your use only and does not constitute an invitation or offer to subscribe for or purchase any of the
products or services mentioned. The information provided is not intended to provide a sufficient basis on which to make an investment decision. It is intended
only to provide observations and views of individual traders or sales personnel, which may be different from, or inconsistent with, the observations and views of
Credit Suisse research department analysts, other Credit Suisse traders or sales personnel, or the proprietary positions of Credit Suisse. Observations and
views expressed herein may be changed by the trader or sales personnel at any time without notice. Past performance should not be taken as an indication or
guarantee of future performance, and no representation or warranty, expressed or implied is made regarding future performance. The information set forth
above has been obtained from or based upon sources believed by the trader or sales personnel to be reliable, but each of the trader or sales personnel and
Credit Suisse does not represent or warrant its accuracy or completeness and is not responsible for losses or damages arising out of errors, omissions or
changes in market factors. This material does not purport to contain all of the information that an interested party may desire and, in fact, provides only a
limited view of a particular market. Credit Suisse may, from time to time, participate or invest in transactions with issuers of securities that participate in the
markets referred to herein, perform services for or solicit business from such issuers, and/or have a position or effect transactions in the securities or
derivatives thereof. The most recent Credit Suisse research on any company mentioned is at http://creditsuisse.com/researchandanalytics/
Please follow the attached hyperlink to an important disclosure: https://www.credit-suisse.com/sites/disclaimers-ib/en/market-commentary.html. Structured
securities, derivatives and options are complex instruments that are not suitable for every investor, may involve a high degree of risk, and may be appropriate
investments only for sophisticated investors who are capable of understanding and assuming the risks involved. Supporting documentation for
any claims, comparisons, recommendations, statistics or other technical data will be supplied upon request. Any trade information is preliminary
and not intended as an official transaction confirmation. Use the following links to read the Options Clearing Corporations disclosure document:
http://www.optionsclearing.com/components/docs/riskstoc.pdf
Because of the importance of tax considerations to many option transactions, the investor considering options should consult with his/her tax advisor as to how
taxes affect the outcome of contemplated options transactions.

Risks:
1. Call or Put Purchasing: The risk of purchasing a call/put is that you will lose the entire premium paid.
2. Uncovered Call Writing: The risk of selling an uncovered call is unlimited and may result in losses significantly greater than the premium received.
3. Uncovered Put Writing: The risk of selling an uncovered put is significant and may result in losses significantly greater than the premium received.
4. Call or Put Vertical Spread Purchasing (same expiration month for both options): The basic risk of effecting a long spread transaction is limited to the
premium paid when the position is established.
5. Call or Put Vertical Spread Writing (same expiration month for both options): The basic risk of effecting a short spread transaction is limited to the
difference between the strike prices less the amount received in premiums.
6. Call or Put Calendar Spread Purchasing (different expiration months & short must expire prior to the long): The basic risk of effecting a long calendar
spread transaction is limited to the premium paid when the position is established.

2014, CREDIT SUISSE

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