FxWirePro: Spot out underperformances in US sell-offs - Risk-off hedging for TWSE and TWD

Asian equity strategists seem to be quite constructive on equities and reckon that the fundamental risks have diminished post the political events this quarter (Chinese National Congress, Japanese elections etc).

Nevertheless, they are concerned about valuations in the US and the “bull market in everything”, and trust that the encouraging standpoint on Asian equities could be derailed by draw-downs in the US. In an effort to ascertain the sensitivity of Asian equities to severe historical draw-downs in US equities, SG team have looked at previous such episodes of larger than 20% draw-downs. They present results across country indices and sectors, but to summarise, Taiwan stands out to show the most frequent underperformance, closely followed by Singapore and Korea.

The above chart demonstrates the 6-month ATM implied volatility of various Asian indices against the statistic from our Asia equity strategy team’s analysis (% of the time an index has underperformed the S&P 500 in 20% or larger draw-downs). We find that Korea and Taiwan screen as the cheapest volatilities to own.

Buy TWSE downside options to hedge against a wider equity sell-off  Buy TWSE Jun18 10000 strike put for 164 TWD (1.54% premium, ref 10651.11, -28 delta, 13.7% vol).

The sensitivity of Taiwanese equities to any negative re-pricing in global growth, a downturn in the global tech cycle and any escalation in North Korean risks make them ideal as a risk-off hedge for equities. The low volatility makes the case even more compelling. We recommend buying a 6-month OTM put on the Taiwan Stock Exchange Weighted Index (TWSE) to position for any downside in equities.

Risks: the total loss on the option strategy is limited to the premium paid up-front.