Derivatives Strategy

Europe Market Commentary 25 November 2009

Stanislas Bourgois, CFA

+ 44 20 7888 0459
Derivatives Strategy
Raymond Hing
+ 44 20 7888 7247 Sell Equity skew into year-end
! Phase 1 of economic recovery is usually sharp, brief, and followed by a renewed decline. But normally, that's the base for a second,
more sustained rise if and when retail sales/final demand growth picks up ("Phase II of recovery"). According to Credit Suisse Strategist
Jonathan Wilmot, the inter-phase is typically associated with weaker, choppier returns to risky assets in favour of an outperformance by
government bonds.
! Global Industrial Production momentum hit its peak in October and is now slowing (Exhibit 1). Before a hypothetical “Phase II” kicks in,
ISM New Orders are likely to trend lower, having already fallen for two consecutive months, leaving markets in the difficult interim
between Phase I and Phase II of recovery for some time.
! This new environment has been reflected in Equity performance since the beginning of September: cash Equity’s risk reward has
deteriorated, with range-bound markets sending Equity’s information ratio (the ratio of average daily P&L to standard deviation) to only
one fifth of what it was during the initial market rally.
! However we believe that the macro environment is still supportive for risk. Credit Suisse’s Economic Surprise index is still positive.
Europe and the Americas are still going through the most intense phase of recovery and a slowdown in growth momentum in these
regions still seems weeks away (peak in IP momentum there is expected in December).
! We believe that selling the skew could be an interesting alternative to other risky trades into year-end. In vanilla terms, selling the skew
involves selling puts while buying call options (a risk reversal) – an interesting trade when downside implied volatilities are high versus
the upside, as is the case now (Exhibit 2) but a risky one when an adverse market move creates a strong demand for put protection and
implied volatilities are remarked up.
! As shown on Exhibit 3 next page, selling vanilla skew has been one of the great trades of 2009. Since September, range-bound
markets have actually increased the attractiveness of short skew trades while cash Equities’ risk reward plummeted – with the exception
of early November for the SPX, where an adverse move on SPX volatilities created temporary mark-to-market losses (for more on early
November VIX moves, please refer to our US colleague Ed Tom’s Unraveling the recent VIX volatility, dated 13 November).
! One reason for the good performance of short skew is that Equity markets still behave as if underinvested/long protection. Open
interest for SX5E call options, which surged in early Q2 because of put spread collar trading, has been roughly unchanged since then
(Exhibit 4). Conversely, total put open interest has gradually increased as put positions were rolled up as the market rallied, leaving
long-Equity investors well protected and limiting the risk for panic volatility buying on market weakness. This results in lower realised
volatility, vol of vol and vol/equity correlation, an environment in which short skew positions typically thrive (see our detailed analysis
Trading the Volatility Skew, dated Nov 2008). The SPX experience in November shows that selling the skew starts being dangerous
only on days when Equity markets fall by almost 3% - close to 50% realised volatility when Equity index currently realise roughly 20%.

Exhibit 1: IP Momentum per region Exhibit 2: SX5E 3-month 90%/110% volatility skew

+2 Std: 10.70%

10.00%
Volatility (%)

Avg: 7.48%
7.50%

5.00% -2 Std: 4.27%

30-Dec-04 30-Dec-05 30-Dec-06 31-Dec-07 30-Dec-08

SX5E Skew Avg(SX5E Skew) ±2*Std(SX5E Skew)
Source: Credit Suisse Locus

NOTE: The risk of selling uncovered put options can be substantial and may result in losses significantly greater than the premium received.
1
 Derivatives Strategy

Exhibit 3: Systematic 3M, 90/110 risk reversal (delta Exhibit 4: SX5E Dec09 Call Open Interest
hedged, monthly rebalanced, 1m notional))
3,500,000 6,000,000
'1800 '2000 '2200
FTSE
3,000,000 '2400 '2600 '2800
STOXX50E 5,000,000
Cumulative Performance

SPX '3000 '3200 '3400

2,500,000
4,000,000
2,000,000

1,500,000 3,000,000

1,000,000
2,000,000
500,000

0 1,000,000
02/01/09 27/03/09 19/06/09 11/09/09
-500,000
0
-1,000,000 08/12/08 02/03/09 25/05/09 17/08/09 09/11/09

Source: Credit Suisse Derivatives Strategy

Exhibit 5: SX5E Dec09 Put Open Interest

6,000,000
'1800 '2000 '2200
5,500,000

5,000,000 '2400 '2600 '2800

4,500,000

4,000,000

3,500,000

3,000,000

2,500,000

2,000,000

1,500,000
08/12/08 02/03/09 25/05/09 17/08/09 09/11/09

Source: Credit Suisse Derivatives Strategy

2
 Derivatives Strategy

Credit Suisse Derivatives Strategy Disclaimer

Europe Please follow the attached hyperlink to an important disclosure: www.credit-
suisse.com/legal_terms/market_commentary_disclaimer.shtml
Stanislas Bourgois CFA +44 20 7888 0459 stanislas.bourgois@credit-suisse.com
Raymond Hing +44 20 7888 7247 raymond.hing@credit-suisse.com Structured securities, derivatives and options are complex instruments that are
not suitable for every investor, may involve a high degree of risk, and may be
USA appropriate investments only for sophisticated investors who are capable of
Edward K. Tom +1 212 325 3584 ed.tom@credit-suisse.com understanding and assuming the risks involved. Supporting documentation for
Sveinn Palsson +1 212 325 6331 sveinn.palsson@credit-suisse.com any claims, comparisons, recommendations, statistics or other technical data will
be supplied upon request. Any trade information is preliminary and not intended
as an official transaction confirmation. Use the following links to read the
Credit Suisse Europe Equity Derivatives Sales Options Clearing Corporation's disclosure document:

Tom Teague (Head) +44 20 7888 4792 thomas.teague@credit-suisse.com http://www.cboe.com/LearnCenter/pdf/characteristicsandrisks.pdf

Because of the importance of tax considerations to many option transactions,
UK and US Institutions/Hedge Funds the investor considering options should consult with his/her tax advisor as to
Simon Munroe +44 20 7888 2752 simon.munroe@credit-suisse.com how taxes affect the outcome of contemplated options transactions.
Helena Clavel Flores +44 20 7888 6528 helena.clavel-flores@credit-suisse.com
All references to Credit Suisse herein include all of the subsidiaries and affiliates
Jacob Killion +44 20 7888 4781 jacob.killion@credit-suisse.com
of Credit Suisse operating under the Credit Suisse name. For more information
Ayfer Bayar +44 20 7888 3533 ayfer.bayar@credit-suisse.com on our structure, please follow the attached link:

Germany/Scandinavia http://www.creditsuisse.com/en/who_we_are/ourstructure.html
Oliver Groeteke +49 69 75 38 2124 oliver.groeteke@credit-suisse.com This material has been prepared by individual sales and/or trading personnel of
Dirk Bombe +49 69 75 38 2122 dirk.bombe@credit-suisse.com Credit Suisse Securities (Europe) Limited or its subsidiaries or affiliates
Wolfgang Faust +49 69 75 38 2123 wolfgang.faust@credit-suisse.com (collectively "Credit Suisse") and not by Credit Suisse's research department. It
Mikael Anden +44 20 7888 6810 mikael.anden@credit-suisse.com is not investment research or a research recommendation for the purposes of
FSA rules as it does not constitute substantive research or analysis. All Credit
France/Benelux Suisse Investment Banking Division research recommendations can be
David Cohen +44 20 7888 0773 david.cohen@credit-suisse.com accessed through the following hyperlink: <http://www.credit-
Mustapha Arhab +44 20 7888 6221 mustapha.arhab@credit-suisse.com suisse.com/researchandanalytics> subject to the use of a suitable login. This
Anne-Lise Bouaziz +33 1 70 39 01 12 anne-lise.bouaziz@credit-suisse.com material is provided for information purposes, is intended for your use only and
does not constitute an invitation or offer to subscribe for or purchase any of the
products or services mentioned. The information provided is not intended to
Italy
provide a sufficient basis on which to make an investment decision. It is
Vincenzo Spadaro +44 20 7888 2730 vincenzo.spadaro@credit-suisse.com intended only to provide observations and views of the said individual sales
Luca Mammoliti +44 20 7888 0784 luca.mammoliti@credit-suisse.com and/or trading personnel, which may be different from, or inconsistent with, the
Luca Lodi-Rizzini +44 20 7888 3318 luca.lodirizzini@credit-suisse.com observations and views of Credit Suisse analysts or other Credit Suisse sales
and/or trading personnel, or the proprietary positions of Credit Suisse.
Iberia Observations and views of the salesperson or trader may change at any time
Maite Suarez +34 91 423 16 51 maite.suarez@credit-suisse.com without notice. Information and opinions presented in this material have been
obtained or derived from sources believed by Credit Suisse to be reliable, but
Emerging Markets Credit Suisse makes no representation as to their accuracy or completeness.
Steve Jobbber +44 20 7888 6912 steve.jobber@credit-suisse.com Credit Suisse accepts no liability for loss arising from the use of this material.
This material is directed exclusively at Credit Suisse's market professional and
Galina Bezuglaya +44 20 7888 0913 galina.bezuglaya@credit-suisse.com
institutional investor customers, i.e. market counterparties and intermediate
Jean-Paul Larcheveque +44 20 7888 0913 jean-paul.larcheveque@credit-suisse.com
customers as defined by the rules of the Financial Services Authority. It is not
intended for private customers and such persons should not rely on this material.
Structured/Hedge Funds Moreover, any investment or service to which this material may relate, will not be
Matt Shelton +44 20 7888 7032 matthew.shelton@credit-suisse.com made available by Credit Suisse to such private customers. All valuations are
Stephanie Hoefling +44 20 7888 4248 stephanie.hoefling@credit-suisse.com subject to Credit Suisse valuation terms. Information provided on trades
executed with Credit Suisse will not constitute an official confirmation of the
Listed Sales & Trading trade details.
Nathaniel Foster +44 20 7888 4427 nathaniel.foster@credit-suisse.com
Credit Suisse Securities (Europe) Limited is authorised and regulated by the
Daniel Carr +44 20 7888 3473 daniel.carr@credit-suisse.com Financial Services Authority.
Azeem Arshad +44 20 7888 1776 azeem.arshad@credit-suisse.com
Divya Taank +44 20 7888 5665 divya.taank@credit-suisse.com
Edward Philipps +44 207 888 1364 edward.philips@credit-suisse.com
Matthew Brown +44 20 7888 0248 matthew.brown.2@credit-suisse.com