Trading strategy recommending volatility dispersion trade on EU banks

Volatility in Europe Buy EU banks dispersion: (+) basket call, (-) worst-of calls Trade: Long Dec17 105% call on an equally weighted basket of SAN, BNP, ING, ISP & DBK*, short Dec17 ATM worst-of call on the same basket for 1.8% indic. (correl bid: 81%). * We pick the top 5 stocks with the largest market cap within the SX7E (EU banks sector index) corresponding to 5 different countries We have previously highlighted our preference for vol dispersion trades both in the US and the EU — with the most recent recommendation being sector dispersion opportunities within the EU. In a similar vein, we suggest positioning for greater dispersion within EU banks via buying a call on a basket of Santander, BNP Paribas, ING, Intesa and Deutsche Bank part-financed by selling a worst-of call on the same basket as: ¢ Improving macro/earnings, sensitivity to rates and regulatory headwinds likely to lead to greater differentiation within banks: An improving macro backdrop in Europe & ongoing improvement in EPS revisions (see Style Cycle) paint a bullish picture for EU banks as they are seen as leveraged macro plays within the EU. However, we believe there is a potential for greater differentiation within banks as our bank analysts have argued before (here and here} that: (i) some banks stand to benefit more than others based on their earnings power should the uptick in the earnings cycle continue, (ii) banks’ gearing to interest rate cycles, and therefore likely impact from a more hawkish ECB, varies between different banks and (iii) French and Benelux banks are likely to be most impacted under potential Basel IV regulations. + Entry point is attractive given historically low implied vols: The structure benefits from its long vol bias as average 6M implied vol on the basket of 5 European banks is historically low (13% %-ile since Jan-08, Chart 16). ¢ High implied correlation beneficial for structure’s short correlation bias: Chart 17 shows the average pairwise 6M and 3M realised correlations between the 5 EU banks, which are historically low. Despite this recent drop in realised correlations, implied correlation is priced higher, thus providing an interesting entry point for the (short-correlation) trade. Bankof America <> ; dee Ios Merrill Lynch Global Equity Volatility Insights | 20 June 2017 9 HOUSE_OVERSIGHT_014980