EFTA01451190.pdf

9 January 2014 FX Blueprint: Thin end of the wedge Trade 3: Leverage the USD/JPY skew: The supposed stalling of Abenomics 'third-arrow' reforms, Weekly change in spot versus risk reversal at extreme uncertainty on tapering and likely poor investor timing in the USD/JPY trade has seen risk reversals 0.18 i t/SDJPY depotr8rr diverging from spot for much of the second half of 0.16 2013. The current level of divergence, at <1.9% 0.10 percentile over the past decade, is nearing historical 10 year low o 12 extremes (chart 4). Since the '08 financial crises there had been only two episodes where this occurred, in 0.10 Q1 2012 and Q1 2013, each time followed by a 0 08 strong reversion of risk reversals to spot. 006 0 04 Beyond historical precedent, we see two drivers that 0 02 may propel risk-reversals higher. A steepening of the US yields and further traction of Abenomics would 0 00 argue for a firmer spot-risk-reversal correlation in the -002 near term, as uncertainty in both whiplashed riskies 04 05 06 07 08 09 10 11 12 13 10 for much of H2. Furthermore, if spot moves higher in Sans 846 dectttIwolliv 3AI arm intley sgetininith•v•in•«W aI 'tat inst.' line with our forecasts, the impact of hedging of structured notes should then become a stronger driver of mid to back-end risk-reversals. The most Spots diverge but implied correlation near highs important driver here is outstanding 25-30Y Power- Reverse Dual Currency notes, of which we estimate a 1.10 120% sizable portion with knock-outs are centered around 1.00 110% the 112.5-120.0 bucket. Risk reversals should then find support as demand-supply imbalances are 0.90 100% reduced from lesser hedging requirements. 0.80 90% 0.70 We thus recommend USD/JPY options that buy the 80% risk reversal targeting the 6M-12M tenors. Consider a 0.60 9-month USD/JPY 109 call funded by selling a 70% 0.50 102/91.50 RKI put for zero cost off spot ref 104.40. 60% 0.40 Trade 4: Lower USD-CAD beta Implied correlation 0.30 50% between AUD/USD and AUD/CAD has remained 40% 0 20 elevated (-86% percentile), which provides sizable Jan-03 Jan-05 Jan-07 Jan-C9 Jan-11 Jan-13 cheapening to AUD/USD puts by selling correlation. Source' oancM an Slocnteg N'W-IIF This relationship relates to CAD being perceived as a USD substitute, which we think will not be the case as Fed tapering spurs bond repatriation and When returns fall AUD/USD underperforms AUD/CAD underscores policy divergence between the two. Thus, consider a 6M AUD/USD 0.86 put with an 40% AUD/USD 6M return - AUD/CAD 6M return AUD/CAD 0.83 cross knock-out indicatively for AUD/USD auto AUD/CA' KO barner 136bps versus 190bps for the vanilla, off spot refs 30% 0.8920 (-3.6% from strike) and 0.9580 (-13.4% from 20% the barrier). 10% Empirically, since the 1983 AUD floatation AUD/CAD 0% dips have been more constrained than AUD/USD, unsurprisingly given the broad dollar response and •10% 41.0,0 cyclical co-sensitivity of commodities (see highlights -20% in chart 3). Historically, a -3.6% AUD/USD put with an -13.4% AUD/CAD KO would have been in-the- -30% money 26.2% of the time, and knocked out 2.7% of the time. .40% ttt tt 84 86 88 90 92 94 96 98 CO 02 04 06 08 10 12 14 Nicholas Wang, London, Saone Oasis ant Sentrep Ammo LP James Malcolm, London, Page 22 Doutscho Bank AG/London CONFIDENTIAL — PURSUANT TO FED. R. CRIM. P. 6(e) DB-SDNY-0 107492 CONFIDENTIAL SDNY_GM_00253676 EFTA01451190