EFTA01461321.pdf

From: Tazia Smith Sent: 1/28/2014 12:24:03 PM To: [email protected] CC: Paul Morris Vinit Sahni Nav Gupta Vahe Stepanian Subject: Depressed options volatility makes 'Renmimbi weaker' hedges very cheap I KCP Capital Markets [II Classification: For internal use only Jeffrey - Curious for your view on China. We're concerned about the defense of China's stability (even by our own Global Markets Research analyst, Jun Ma). China may be re-rating for longer-term stability as an 'emerged' market, but that our DB GEM Equity Strategist, Jean-Paul Smith, and his team may have the downside risk right in the nearer-term. Bulls point to estimates that the AUM in the trust sector only totalling Rmb 10.1 trillion (arguably too low), and that 93% of AuM in trust products could be "backed" (38% by central government, 34% by local governments, and 21% by large financial groups ). But Bears highlight that (a) bailouts by authorities won't be a sustainable solution to increasingly regular defaults, (b) they suggest the inherent moral hazard problem that will perpetuate high-risk borrowers leveraging the shadow banking system (vs. the proposed quotad bond market issuance and bank securitization channels that the government intends to promote to increase transparency and liquidity), and, (c) bears also point out that local authorities, supposedly on hand to intervene in troubled loans, are themselves highly indebted (currently account for the highest proportion of credit in China, and news flow of local government/ LGFV debt rollovers is becoming all too common - according to DB GEM Equity Strategists, 1/28/14). As Nav points out below, there is a crowded long China trade with leverage, financed by selling options. Calls on USDCNH present a convex payoff caused by investors selling too many options - timeframe on a move is uncertain which is why he picked 1y (2y options are not very liquid). Please see below, let us know your thoughts. Best Regards, Tazia — Forwarded by Tata Smith on 01/28/2014 11:58 AM -- From' Nav Gula To. Date. 0182882014 09:44 AM Subject: Depressed options volatility makes 'Renmimbi weaker' hedges very cheap I KCP Capital Markets VI USDCNH call options underprice the possibility of higher USDCNH. This could result from unwinding of heavy positioning long CNH vs USD resulting from credit tapering, investor awareness of worsening bank asset quality and declining growth. The correlation between China and other EM is presently low. Sustained outflows from broader EM will likely impact China also 1) Buy a 1y expiry, 6.2 / 6.7 strike USDCNH call spread. Premium (offer) -0.43% of USD notional. Spot breakeven 6.226 2) Buy a 1y expiry, 6.3 / 6.8 strike USDCNH call spread. Premium (offer) —0.30% of USD notional. Spot breakeven 6.318 USDCNH spot = 6.029, 1y ATMF = 6.093 hidieann keels on le, Nut-tied to markei mo‘cmcni. Satin:0: 1AS KCP London, 1.'2814. CONFIDENTIAL - PURSUANT TO FED. R. CRIM. P. 6(e) DB-SDNY-0 123292 CONFIDENTIAL SDNY_GM_00269476 EFTA01461321