Goldman Sachs is recommending investors speculate that the equity volatility spread between the European banking and insurance sectors should compress because of the belief that bank exposure to credit risk is not completely priced in for some banking names. Atlaf Kassam, associate in European equity derivatives strategy in London, said the firm is pitching the idea of selling Aegon implied volatility and buying Credit Lyonnais implied volatility to capture the tightening of the spread.
The firm chose Credit Lyonnais because its stock has one of the lowest levels of implied volatility in the sector and equity prices for French wholesale banks are too optimistic, Kassam said. Aegon's pending rights issue, however, may actually be a positive for its stock since the cash infusion might help clean up the company's balance sheet, he added. Goldman specifically is recommending selling a put on Aegon at a strike price of EUR8.6 and an expiration of Dec. 20 with an implied volatility of 90.5%. At the same time, the investor would buy a put on Credit Lyonnais at a strike price of EUR23.7 and an expiration of Dec. 20 with an implied volatility of 65.6%. Credit Lyonnais closed at EUR29.3 and Aegon closed at
EUR10.8 on Thursday.
A rival strategist said he would not pitch this trade because he thinks the insurance industry still faces larger risks than the banking sector. Insurance companies are under-funded and if the equity market continues to fall they will be forced to sell more equities and invest in fixed income. Martin Boldt-Christmas, equity derivatives analyst at UBS Warburg in London, agreed that implied vol is high and should fall, but he thinks there is still room for a spike caused by geopolitical issues--such as war with Iraq, and is therefore not recommending this strategy.
