Friday, December 10, 2010


From Pragmatic Capitalist:
If you’re a raging bull on equities you’d be a fool not to consider some exposure to the higher growth region of Asia.  And as a raging bull on equities in 2011 Goldman Sachs has laid out their favorite trades for Asia in the coming year:

1. Our three favorite markets for 2011 are the lowest vol markets globally. KOSPI 200, TWSE, and MSCI Singapore are three of the lowest implied vol markets in the world. On each of these three markets, owning 6-mo 110% upside calls costs less than 2% and is a reasonably easy way to put on long exposure with limited risk. While we have often suggested long AEJ vs. short DM trades, our more positive DM view makes us prefer the simplicity of simply using calls for exposure. Currently 6-mo 110% calls cost 1.75%, 1.71%, and 1.25% on KOSPI2, TWSE, and MSCI Singapore, respectively. Risk is loss of premium.

2. HSCEI vs. SPX 1-year variance is our favorite China inflation hedge, but NKY vs. SPX 1-year variance also carries very well. We believe the three ingredients to a strong derivative trade are (1) A good fundamental story; (2) An attractive entry point; and (3) Historical profitability. The HSCEI vs. SPX 1-year variance trade satisfies all three criteria, as we discussed Thursday in our piece China inflation hedge with positive carry: HSCEI vs. SPX variance. The Nikkei 225 vs. S&P 500 1-year variance pair satisfies two of the three factors, given historical profitability and an attractive entry point, though we have less of a fundamental case relative to the HSCEI vs. SPX pair. Sellers of variance swap risk unlimited loss at expiry;
buyer of variance swaps risk losing var strike^2 / (2 * var strike) at expiry.

3. HSCEI and oil correlations have begun to decline with oil prices moving lower and HSCEI moving higher. Two of our macro views for 2011 are high commodity prices and muted returns for emerging markets. On this note, it is interesting to see HSCEI and WTI have begun to de-correlate. Given our view that inflation is a problem for China, the correlation could remain low. Owning puts on HSCEI contingent on oil prices higher plays into this trend. Current 3-mo ATM puts on HSCEI contingent on WTI up 10% cost 1.2%, a 80% discount to ATM vanilla puts. Risk is loss of premium.
...Four More