Friday, September 30, 2011

EU and US Financials - Vols and Risk Starting to Decouple?

Let's examine the largest US banks against their European counterparts, using BAC and C for the US proxies, and DB and UBS as the European proxies. We'll note an interesting divergence that is developing as the market is finally reflecting differing risk between the two. The LIVEVOL® Pro Summaries are included below.


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For quite sometime, there was a compelling argument that the EU and US were essentially trading in tandem -- with news from one moving news in the other and a two way causality. From the Summaries above, we can see similar vols, so that similarity in risk premium seems relatively stable, but, one thing has changed -- and quite significantly.

Let's look to the vol charts for these four firms -- these are two year IV30™ charts.

Ok, so, what are we looking at?...

First, the similarities:
For all four charts, the implied is substantially elevated right now relative to the last two years, in some cases nearly triple the values from the past.

For the top two charts (US banks), we can see that the IV30 has come down off of highs. Specifically:

BAC is 40% off of it's IV30™ high
C is 26% off of it's IV30™ high

For the bottom two charts (EU), the banks are at or near highs -- in the case of UBS, making a new high today.

DB is 10% off of it's IV30™ high
UBS is 0% off of it's IV30™ high (a new high today)

Not convinced of the diverging behavior, yet? Try this. The EU banks are actually showing realized vol in line (actually above) the implied. In other words, the option market reflected risk is pacing the actual movement of the stock almost perfectly. In the US, the stocks are actually moving with lower realized vol than the implied reflects. Specifically, the HV20/IV30™ ratios are:

BAC: 77%
C: 88%
DB: 103%
UBS: 102%

Just to show I'm not cherry picking -- here are the same ratios for WFC and CS:

WFC: 79%
CS: 133%

Same phenomenon. Using these two for the prior stat:

WFC is 27% off of it's IV30™ high
CS is 11% off of it's IV30™ high

Again, the same phenomenon as before, with US bank stocks further off of the IV30™ annual high than the EU stocks.

So what? It seems that the EU and it's "problems" are finally decoupling (slightly) from the US and its "problems." The causality is still two-sided, but the vol behavior (or risk as reflected by the option markets) is finally diverging. The EU is showing greater realized vol to implied while the implied makes new highs. The US is showing a dipping implied off of highs, which is still elevated to the realized movement of stock. Hmmm... What pair trades are now available?

This is trade analysis, not a recommendation.

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