PANEL CONVERSATION: Exploring the Relationship Between Equity - PowerPoint PPT Presentation

PANEL CONVERSATION: Exploring the Relationship Between Equity Option Implied Volatility and Credit Spreads M A R C H 2 6 , 2 0 1 9 , C B O E R M C , C A R L S B A D O L I V I E R S A R F AT I , H E A D O F E Q U I T I E S G E N T R U S T O L I V I E R @ G E N T R U S T W M . C O M For Institutional Use Only

A Short History of Credit and Implied Volatility Before 2002 The Pioneers Credit Equities Derivatives Hedge the convertibility with Converts Call Options LEAPS Hedge default risk with stocks Stocks Distressed Cash For Institutional Use Only S T R I C T L Y C O N F I D E N T I A L 1

A Short History of Credit and Implied Volatility Before 2002 2002 - 2003 New Entrants took advantage of cheap puts / mispriced skew Credit Equities Derivatives Buy cheap bond + hedge default risk with OTM puts Far OTM Examples: Bonds Put Options Autos Airlines Risk-Arb Risk of Default Risk of Default p q Cash For Institutional Use Only S T R I C T L Y C O N F I D E N T I A L 2

2004 – 2007 : the Rise of Models 1974 ‘90s KMV 2002 RiskMetric 2003 Hull, Nelken, White Merton Equity = call on Assets EDF CreditGrades Uses option skew struck at Liabilities Expected Default Frequency Stock Implied Vol / skew Implied CDS Actual CDS Spread Model Book Value / Debt Spread Greeks / Hedge Ratios Worked well for traditional corporations (Homebuilders, Autos, Industrials, Airlines,…) For Institutional Use Only S T R I C T L Y C O N F I D E N T I A L 3

A Short History of Credit and Implied Volatility Before 2002 2002 - 2005 2004 - 2007 Capital Structure Relative Value: the Rise of the Model Credit Equities Derivatives OTM Single options name CDS Long dated options Bonds Stock Trades: - Mispriced CDS / Implied Vol, but beware LBO, M&A - Or, take a stance on change in Capital Structure Cash - Provide liquidity at times of crises For Institutional Use Only S T R I C T L Y C O N F I D E N T I A L 4

2006 – 2011: Credit Indices Run the Show Source: Bloomberg, Citigroup For Institutional Use Only S T R I C T L Y C O N F I D E N T I A L 5

2006 – 2011: Credit Indices Run the Show Source: Bloomberg, Citigroup For Institutional Use Only S T R I C T L Y C O N F I D E N T I A L 6

2006 – 2011: Credit Indices Run the Show Source: Bloomberg, Citigroup For Institutional Use Only S T R I C T L Y C O N F I D E N T I A L 7

A Short History of Credit and Implied Volatility Before 2002 2002 - 2005 2004 - 2006 2006 - 2011 Credit Index vs. ETFs IG Options vs SPX Options Equities Derivatives Credit SPX IG Options Options IWM CDX HY SPY CDX IG Cash For Institutional Use Only S T R I C T L Y C O N F I D E N T I A L 8

A Short History of Credit and Implied Volatility Before 2002 2002 - 2005 2004 - 2006 2006 - 2011 2011 - 2015 The Rise of the ETFs Credit Equities Derivatives HYG HY Options options CDX HY HYG VXX VIX futures SPX IG Options Options CDX IG SPY Cash For Institutional Use Only S T R I C T L Y C O N F I D E N T I A L 9

A Short History of Credit and Implied Volatility Before 2002 2002 - 2005 2004 - 2006 2006 - 2011 2011 - 2015 Today New Entrants HY futures Credit Equities Derivatives HYG HY Options options HYG CDX HY VXX VIX futures SPX IG Options Options CDX IG SPY Cash IG Futures For Institutional Use Only S T R I C T L Y C O N F I D E N T I A L 10

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