BofAML pitching calendar risk reversal strategy

Singapore

FOR US equity investors wary of a sell-off but loath to miss out on a stocks rally, Bank of America Merrill Lynch (BofAML) is pitching an options strategy known as a calendar risk reversal.

Relatively muted swings and a wide price gap between bullish and bearish options bets means it is attractive to sell a medium-term put on the S&P 500 Index and buy a shorter-dated call, strategists including Gonzalo Asis and Stefano Pascale wrote in a note on Tuesday.

Such trades generally outperform if the underlying index breaks higher and they are cheaper than simply purchasing calls until any equity selloff reaches about 5 per cent, a rare occurrence, the strategists said. As of Tuesday morning, the entry point for their preferred trade was the most attractive in 18 years, they added.

"At today's levels, we like calendar risk reversals for equity replacement to position for a breakout higher in US equities while reducing exposure to moderate drawdowns," they wrote. "It is clearly the preferred trade when the S&P is flat to mildly lower."

US stocks sold off and volatility rose on Tuesday as the Democrat-controlled House opened a formal impeachment inquiry against President Donald Trump. While the move added to a raft of investor concerns including trade tensions and disappointing economic data, by some measures implied volatility is above its realised counterpart.

The Bank of America team suggests that investors look at selling three-month puts to buy a one-month call, and recommended closing the trade when the shorter-dated option expires. That fits with their bullish view on risk assets amid a myriad of headwinds and risks. "Our house view remains bullish risk assets, but an abundance of headwinds and risks are challenging a stronger move higher in US equities," they said. "Have your equity cake without 'eating it' if risks materialise." BLOOMBERG