Monday, March 22, 2010

Equity Derivatives Dynamics European Trade Ideas March 2010 $SPY

• Options market is assigning lower probability to tail events over the next year. We look at the option market’s expectation of 1 Y prospective price changes at 5 different points of time in recent past. Probability of tail events has come down significantly since March 09 for both S&P 500 and SX5E and we are closer to the bull market levels.

• Given the decline in volatility, we recommend investors to use cheap optionality to express their directional views. Recent events in Greece remind us of the dangers of being too complacent. With markets ~10% above our strategy team year end forecast, upside in near term looks capped. While volatility may grind lower, the cost of optionality has declined significantly vs the recent past, especially at the front end. (Exhibit 4).

Equity Derivatives Dynamics

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