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How to make money from volatility rise: Morgan Stanley's ideas

[SYDNEY] Prospects for a winding back of central bank stimulus this year, along with a potential pick-up in global inflation, have boosted the risk of greater fluctuations in asset markets that have largely moved in tandem in recent years.

Exactly how you can make money if indeed bigger swings in asset prices materialise is a tougher call than just buying and holding. Expensive financing - or carry - costs in many markets mean investors have to pay up for potential returns from price swings. Morgan Stanley analysts have mapped out several proposals, including using options to bet on higher oil prices and increased stress in the high-yield bond market.

While the factors holding down price swings are powerful and are unlikely to change within the next three months, they may not last into the next few years, Morgan Stanley's cross-asset analysis team concluded. They're not alone expecting a shake-up - investors see a 74 per cent probability that equity-price swings will widen in 2018, according to a survey of 229 investors representing US$6 trillion in managed assets conducted by Absolute Strategy Research.

Here are some trades that Morgan Stanley analysts including Andrew Sheets recommend:

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Buy call options on the Euro Stoxx 50 Index that pay off if the index is at least 2 per cent higher within six months and sell puts with a strike 10 per cent below current levels;

Buy Brent crude one year at-the-money-forward calls at a cost of 7 per cent;

Consider put spreads on high-yield credit default swaps. Bond guru Bill Gross last year said he was using the Markit CDX North American High Yield Index to hedge against wider spreads'

Buy foreign exchange options that pay off if the Australian dollar weakens against the yen. Japan's currency is typically a haven in times of global stress;

Relative to Treasuries, take short positions in mortgage-backed securities issued by agencies such as Fannie Mae and Freddie Mac.

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