Demand for Asian equity-linked notes is expected to plummet as implied volatility hits all-time lows. Bankers said the multi-billion dollar ELN business could see volumes fall because the notes no longer offer high yields. Nicholas Cohen-Addad, head of equity derivatives at Credit Lyonnais in Hong Kong, said if volatility remains compressed at current levels for three-to-six months, the ELN markets will be severely curtailed. "They're becoming a lot less attractive," he added. Another trader said, "This could kill the ELN market."
"While volatility has dropped worldwide, vols in Korea have fallen more so and have hit record lows," said James Rodríguez de Castro, managing director in global equity-linked products at Merrill Lynch. In Korea, one-month implied volatility has fallen to 20% from around 37% in April. Levels have also dropped to near all-time lows in other major Asian markets including Hong Kong and Taiwan.
Traders said several factors have caused vols to fall in the massive Korean market, including low summer activity and the KOSPI 200 index clawing out gains of some 30% in the last few months. In addition, structured products have neared barrier levels, causing banks to offload volatility and further compress levels. Alex Ypsilanti, v.p. in equity derivatives research at Merrill in Hong Kong, said, "In the absence of a catalyst, vols have come off," explaining that with a steady market rally, without panic, volatility tends to fall. He further explained that the fall in levels has been more pronounced in the Asian region because of the strong equity outperformance versus the U.S. or Europe.
"These lows will ultimately shift people into other products," said an official at Goldman Sachs. For example, a trader at a European bank said a few months back a typical vanilla ELN in Asia would have yielded around 5-6%, while now it would offer around 3.5-4%.
Conversely, products in which end-users buy volatility, such as warrants, capital guaranteed products, as well as outright over-the-counter options, are expected to grow in market share in the coming months.