Volatility spike suggests index option plays, says BoA ML

With index spreads having widened, Bank of America Merrill Lynch strategists suggest there is considerable value in owning deep out-of-the-money receivers for investors that see market direction as more balanced or want to hedge a low-beta portfolio for a sharp move tighter.

Extreme macro uncertainty owing to mixed headlines for sovereigns has led to a spike in credit market volatility, notes BoA ML. Strategists expect that realised volatility will stay elevated until there is clarity regarding sovereigns, with further room for implied volatility, particularly for OTM options, to increase. In addition, short-dated volatility and super-senior index tranches are expected to become more expensive as investors look to hedge both upside and downside tail scenarios.

Top global trade ideas include playing CDX IG12 and HY13 options, going long two times an 85bp receiver versus short a 95bp receiver in IG, or going long the 94/92bp payer spread on HY for portfolio hedging.

In iTraxx Europe index options, BoA ML sees value in going long two times a 70bp receiver versus short an 85bp receiver. Alternatively, correlation traders could short the five-year series nine 6-9% tranche while going long the 9-12%, delta-hedged.