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

PANEL CONVERSATION:

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

Exploring the Relationship Between Equity Option Implied Volatility and Credit Spreads

For Institutional Use Only

S T R I C T L Y C O N F I D E N T I A L

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A Short History of Credit and Implied Volatility Before 2002 Credit Equities Converts Derivatives Cash Distressed Call Options Stocks

Hedge the convertibility with LEAPS Hedge default risk with stocks

The Pioneers

For Institutional Use Only

S T R I C T L Y C O N F I D E N T I A L

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2002 - 2003 Credit Equities Derivatives Cash Bonds Before 2002 Far OTM Put Options

Buy cheap bond + hedge default risk with OTM puts

New Entrants took advantage of cheap puts / mispriced skew A Short History of Credit and Implied Volatility Examples: Autos Airlines Risk-Arb

Risk of Default p Risk of Default q

For Institutional Use Only

S T R I C T L Y C O N F I D E N T I A L

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2004 – 2007 : the Rise of Models Equity = call on Assets struck at Liabilities Model Stock Implied Vol / skew Book Value / Debt EDF

Expected Default Frequency

‘90s KMV CreditGrades 2002 RiskMetric Implied CDS Spread 1974 Merton 2003 Hull, Nelken, White Uses option skew Actual CDS Spread Worked well for traditional corporations (Homebuilders, Autos, Industrials, Airlines,…) Greeks / Hedge Ratios

For Institutional Use Only

S T R I C T L Y C O N F I D E N T I A L

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Credit Equities Single name CDS Derivatives Cash Bonds 2002 - 2005 Before 2002 2004 - 2007 OTM

• ptions

Stock Capital Structure Relative Value: the Rise of the Model Long dated

• ptions

Trades:

• Mispriced CDS / Implied Vol, but beware LBO, M&A
• Or, take a stance on change in Capital Structure
• Provide liquidity at times of crises

A Short History of Credit and Implied Volatility

For Institutional Use Only

S T R I C T L Y C O N F I D E N T I A L

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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

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Source: Bloomberg, Citigroup

2006 – 2011: Credit Indices Run the Show

For Institutional Use Only

S T R I C T L Y C O N F I D E N T I A L

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Source: Bloomberg, Citigroup

2006 – 2011: Credit Indices Run the Show

For Institutional Use Only

S T R I C T L Y C O N F I D E N T I A L

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Credit Equities Derivatives Cash SPX Options CDX IG CDX HY IG Options 2002 - 2005 Before 2002 2004 - 2006 IWM SPY Credit Index vs. ETFs IG Options vs SPX Options A Short History of Credit and Implied Volatility 2006 - 2011

For Institutional Use Only

S T R I C T L Y C O N F I D E N T I A L

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Credit Equities Derivatives Cash SPX Options CDX IG CDX HY IG Options 2002 - 2005 Before 2002 2004 - 2006 HYG

• ptions

SPY The Rise of the ETFs A Short History of Credit and Implied Volatility 2006 - 2011 HY Options HYG VXX 2011 - 2015 VIX 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

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Credit Equities Derivatives Cash SPX Options CDX IG CDX HY IG Options 2002 - 2005 Before 2002 2004 - 2006 HYG

• ptions

SPY New Entrants A Short History of Credit and Implied Volatility 2006 - 2011 HY Options HYG VXX 2011 - 2015 VIX futures Today HY futures 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

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Important Disclaimers

The information presented is for institutional use only. This presentation is for information purposes only and does not constitute a solicitation for services or for the purchase or sale of any securities. Although the information presented is from sources believed to be reliable, we do not represent that such information is accurate or complete, and it should not be relied upon as such. . No projection or representation can be made regarding future performance results. Past performance is not a guarantee of future results. There are special risks associated with options and in particular with uncovered options writing which exposes prospective investor to potentially significant loss. For additional information about the risks of options investing, please refer to the “Characteristics and Risks of Standardized Options” brochure available through the Options Clearing Corporation https://www.theocc.com/about/publications/character- risks.jsp. GenTrust is an investment advisor with offices in Miami, FL and New York, NY. For information regarding GenTrust’s products, services, fees and business practices, please refer to GenTrust’s Form ADV Part 2A Brochure filed with the U.S. Securities and Exchange Commission (“SEC”) and publicly available at the SEC’s website www.adviserinfo.sec.gov.