​Weekly Flow Report: Spread Trades In Favor ¦ Year-End Institutional Hedging ¦ Nikkei Profit Tak

The EQDerivatives weekly flow report summarizes the major trades and trends of the week as observed by sellside desks and portfolio managers globally. This week, we look at the current flow from hedge funds in spread trades between U.S. and European underlyings, a pickup in institutional hedging into year-end, and profit taking in the Nikkei post the Bank of Japan announcement to ratchet up is quantitative easing program. NORTH AMERICA The growing trend being recognized by sellside firms is the significant amount of foreign money coming in to the U.S., with North American hedge funds and institutional investors also cutting their global allocations. “We are seeing Japanese investors using U.S. dollars to buy U.S. equities, for example. Pretty everyone is using the U.S. dollar as the risk asset that we haven’t seen since the 1990’s,” said one market participant. “US equities are fairly valued, maybe a little room on the upside but once that starts to occur we will think of that as equities being overvalued. It’s an asset bull market, meaning any U.S. asset is rallying in value and any foreign value is declining in value.” The major flow in the OTC market, and which is growing in popularity, is outperformance spread trades, i.e. buying the Eurostoxx or DAX and selling the S&P 500 against the European index. Three sellside participants noted significant interest in outperformance spread trades, citing attractive fundamentals and parameters around volatility and skew. Separate from those trades, investors—hedge funds in particular—are being more cautious and operating at lower levels after a tough few months. Therefore, capital being deployed in new leverage trades is tapering out, but sellsiders remain optimistic given that asset managers are closing year-end trades and looking at ways of profiting from current market fundamentals. In the listed markets, the VIX continued to move lower, although volume was fairly muted compared to a week earlier. Of the flow, traders noted interest in selling calls in to year-end on the VIX, and buying puts on the VIX and VXX in both November and December maturities. There was profit taking in the SPDR S&P 500 ETF Trust and the iShares MSCI Japan ETF. In terms of active sectors, traders also highlighted put buying in the Market Vectors Oil Service exchange-traded fund, suggesting that the oil drilling sector will be under pressure over the long term. EUROPE After a busy Friday on Oct.31, the week started with top line skew being flat in European underlyings, driving call fly trading in OTC and listed markets. Prior to the European Central Bank meeting on Thursday, the DAX was of focus in terms of deploying upside call positions among asset managers and hedge funds, as the later worried about a gap upwards. “You can’t really have a year where major markets are up in double figures and you are down. Most hedge funds are down 4-6%. We’ve seen some 50 basis points, 20 delta call spreads just in case the market gaps upwards, but it’s been very low conviction stuff,” said one market participant. A few market participants pointed to a lack of overwriters from the hedge fund community, which have historically been very active in the OTC market during this period. For institutional investors, there has been a pickup in hedging into year-end—renewing one-to-five year hedges in the FTSE 100, S&P 500 and Eurostoxx 50 through vanilla structures such as puts and put spreads. Despite much optimism around the ECB meeting and Mario Draghi’s press conference—the options market implying a one-day move of 3.5%–European markets declined at the end of the week, with the Eurostoxx 50 moving from 3,138.57 on Nov. 6 to a close of 3,064.92 on Friday, according to Bloomberg. Dividends were particularly active, with investors buying DEDZ6, although spread trades between DEDZ6 and DEDZ7 had largely tailed off towards the end of the week. In Turkey, participants singled out that there was noticeable put flow in the country’s equity markets, particularly in the iShares MSCI Turkey ETF. The flow comes after the ETF surged higher in October, reaching as high as 55.37 in October, although has since declined, sitting at 51.57 on Friday. ASIA PACIFIC Flow was muted in HSI and the Kospi last week, among other Asia ex-Japan indices, although participants still noted interest in relative value strategies that go long Asia index volatility and short U.S. or European index volatility. Corridor variance swaps, as well as variance swaps, were in favour among investors. There was flow in new positions, while some investors were taking profits on the trade. Market attention still remained on Japanese underlyings, particularly the Nikkei. Investors have been active in taking profits in relative value trades or upside call positions. “Because the Nikkei/S&P 500 carry was very good, and it reverted back up very fast after the BoJ announcement, a lot of people have been taking profit on that,” said one market participant. Others have been restructuring positions on Japan indices so to maintain upside exposure but with flat delta. Typical strategies have involved calendar rolls through call spreads into longer-dated tenors on the Nikkei, Topix and Japanese single stocks. ASIA WATCH: Due to the recent upwards move in the Nikkei, the market is nearing significant knock-outs in structured products at 17,000. As notional is returned to investors, there is expected to be significant issuance in retail structured products leading to an inflow of long-dated vol in Nikkei. EQDerivatives will be following this development closely over the next few weeks. Keep up-to-date on the latest developments globally through EQDerivatives—www.eqderivatives.com—your source of flow and structured products news, commentary and research globally.