Global Equity Volatility Insights Understanding when risk parity risk increases we estimate 68% of the 09 August 2016 Corrected Unauthorized redistribution of this report is prohibited. This report is intended for [email protected] US Quantifying the (bond-equity correlation) risks to risk parity Last week’s sharp sell-off in JGBs renewed concerns of forced selling by risk parity funds. While the drawdowns in US Treasuries, US equities, and ultimately risk parity portfolios were small and short-lived, the latent risk remains worth monitoring, as (i) leverage is still near max levels across a variety of risk parity parametrizations, (ii) bond allocations are historically elevated, and (iii) markets continue to be sceptical of a 2016 Fed hike. Hence we provide a simple scenario tool to help investors assess what relative moves in bonds and equities could catalyse significant deleveraging by rules-based risk parity funds running vol target overlays. For example, a -2% daily decline in the S&P 500 coupled with a -0.6% fall in 10y Treasury prices (poor diversification) could trigger a 25% deleveraging (of unlevered notional) today, whereas a -4% SPX drop and +1% bond rally (good diversification) would generate no selling pressure, underscoring the critical role played by bond-equity correlation in governing the severity of risk parity unwinds. Europe Buy the seasonal oil dip via bullish X-market risk reversals Selling rich USO (WTI tracker) 3M 25d puts to fund cheaper SXEP (European Oil & Gas equity) calls is historically attractive. Indeed the number (>2) of long SXEP calls per short USO put is in the 90 th %-ile since 2008. The trade leverages both our commodity strategists’ ‘buy the dip’ view and our equity strategists’ bullish outlook on the Oil & Gas sector, which has been the worst performing over the last 1M. Moreover, the average payoff of being long SXEP 3M 25d calls would have been >2x greater than USO 3M 25d calls (owing to more frequent positive returns),