Equity Derivatives Dynamics

Transcription

1 GLOBAL Morgan Stanley & Co. Incorporated Sivan Mahadevan +1 (1) Christopher R. Metli Equity Derivatives Dynamics Keeping One Eye on the VIX Morgan Stanley & Co. International plc+ Morgan Stanley Asia Limited+ VIX Grinding Lower Christian Kober, CFA Praveen K. Singh Viktor Hjort Philipp Schoenhuber A bumpy road: We expect both short-dated and long-dated implied volatility to grind lower as we work through a recovery, but there are numerous reasons to expect that it will not be a straight line down VIX VIXV Earnings, credit pause, and QE debate top the list: Early reads on this earnings season indicate that it could be a driver of volatility, at least at the single-name and sector level. Among other potential catalysts, a pause in the credit rally amid a secular repair phase and continued debate over QE exit strategies could drive volatility in the coming months Jan-08 Feb-08 Mar-08 Apr-08 May-08 Jun-08 Jul-08 Aug-08 Sep-08 Oct-08 Nov-08 Dec-08 Source: Morgan Stanley Research, Bloomberg Jan-09 Feb-09 Mar-09 Apr-09 May-09 Jun-09 Jul-09 VIX grinding downward: Despite the reasons for concern, the VIX is falling, now bumping against realized volatility that is trending up past 25%. The move in the front part of the curve has well outpaced 3-month and out maturities, a move we suggest leaning against given the arguments for a near-term pause. VIX a double-edged sword: The VIX is certainly useful as an easy-to-use benchmark, but it represents just one small region of all of the equity volatility metrics that are important. It also offers trading opportunities, but these come at a price. Long gamma for those with risky asset exposure: For investors either long or short risky assets the risk of higher gamma means gap risk. We like directly protecting against such moves, and think volatility for very short-dated options is low enough to warrant buying puts and calls outright in many sectors. We continue to expect correlation to grind lower, and favor buying gamma on the sector and single-name level. Morgan Stanley does and seeks to do business with companies covered in Morgan Stanley Research. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of Morgan Stanley Research. Investors should consider Morgan Stanley Research as only a single factor in making their investment decision. For analyst certification and other important disclosures, refer to the Disclosure Section, located at the end of this report. += Analysts employed by non-u.s. affiliates are not registered with FINRA, may not be associated persons of the member and may not be subject to NASD/NYSE restrictions on communications with a subject company, public appearances and trading securities held by a research analyst account.

2 Keeping One Eye on the VIX Our Re-Risking and Recovery theme involves being long short-dated options while selling longer-dated volatility, even though we believe that if a gradual recovery follows historical patterns, both short-dated and long-dated volatility are likely to move lower. Our justification for leaning against the historical trend is that we expect a bumpy road to recovery, especially considering the headwinds we face in this cycle globally. For those long risky assets, gamma is worth owning in our view, and we take comfort in seeing the VIX rise on days when events that are not in the price (equities) surface. Short-dated implieds are again flirting with the low-20% range and the front part of the term structure is very steep, but the bounce in the first two weeks of July showed that volatility does not necessarily need to decline in a straight line. When we launched our global equity derivatives strategy effort at the beginning of this year, we clearly wanted to cover the market broadly and deeply, and as such, any significant focus on the VIX seemed too narrow. However, we cannot ignore the importance of this benchmark in the market, and given that short-dated volatility is something we follow closely today as we transition between two regimes, we find ourselves (and our clients) very focused on the prices of near-dated options and gamma generally, so keeping one eye on the VIX is quite important. Taking a step back, the VIX is a double-edged sword as an index. At one level, it is critically important to have a broad measure of volatility in the market derived from option prices on the world s most liquid equity index (S&P 500), but the VIX represents just one small region of all of the equity volatility metrics in the market. Furthermore, the 30-day volatility that the index measures may not be that important during periods of growth with little near-term uncertainty, and it might overstate the volatility of the market during times of extreme stress. But today, given our focus on near-term headwinds and the transition to recovery and growth, short-dated volatility might indeed be the most important uncertainty measure. In our discussions with investors of late, that sentiment seems to carry some weight. So what can drive near-term uncertainty? Economic headwinds persist. We had a disappointing employment report in early July, and even though some of it can be blamed on summer employment and the early reporting due to the calendar, a lack of recovery in employment is a key risk. The Morgan Stanley Business Conditions Index (MSBCI) dropped sharply in July (after four months of improvement), owing to renewed weakness in the consumer discretionary space (Business Conditions: Back to Reality, July ). Earnings surprises. With Q2 just ahead of us, we believe markets will welcome better than expected earnings quite positively, and conversely, will be somewhat disappointed with significantly below consensus results. Both are reasons to be long short-dated options and / or gamma. Potential pause in credit healing. Credit has performed well this year, and we maintain our view that it is in a secular repair phase, but tactically we feel there are reasons for a near-term pause including sector dislocations and financial risks resurfacing (see The Summer of George, July 10, 2009). We do see a lot of hedging interest in the credit world as investors look to protect large YTD gains, and this flow could spill over into equities (see Credit Hedging Options on Losses, July 10, 2009). Quantitative easing transition. The transition out of QE is not here yet, but is the market is beginning to price in and debate the removal of support facilities. This is driving high rate volatility, and the Fed s lack of commentary on the exit strategy has kept the uncertainty high at least until Chairman Bernanke s July 21 testimony to Congress. We continue to believe that being long equity gamma make sense while we are still in and through the exit out of QE (see Equities and the QE Quandary, May 12, 2009). Exhibit 1 Rate and Oil Vol Well Above Equity 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Jan-08 Feb-08 Mar-08 3m ATM Crude Vol (LA) 3m ATM SPX Vol (LA) 3M FX Vol * 3 (LA) 1Y10Y Rate Vol (RA) Apr-08 May-08 Jun-08 Jul-08 Aug-08 Sep-08 Source: Morgan Stanley Research, Morgan Stanley Quantitative and Derivative Strategies, Bloomberg Oct-08 Nov-08 Dec-08 Jan-09 Feb-09 Mar-09 Apr-09 May-09 Jun-09 Jul

3 Deflation vs. inflation. That the debate continues for both sides of this coin suggests that the range of equity prices could be quite wide. In particular, a sudden inflationary environment would likely push volatility higher. Exhibit 2 Earnings Dispersion Falling, but Still High Energy prices. Oil volatility has been on the rise, and continued high correlation to stock markets could drive equity volatility higher if oil prices break definitively one way or the other. This could impact equities broadly due to similar drivers (changes in global demand), or be more targeted (impacting certain industries where oil is a cost or revenue). Washington policy action. Healthcare reform, financial system regulation, and energy / climate policy are all being debated this year, with passage on all three at least possible. Even if the likely scenario is for incremental change, debate on or passage of more ambitious proposals could drive volatility. A good investing environment drives demand for hedging. One sentiment we continue to hear from investors is that there are plenty of cheap assets out there in both credit and equities. While there is much concern about short-term price fluctuations, the long-run value of many assets are quite compelling, which is the motivation to invest and is quite different from just a few months ago. Renewed investment amid near-term concerns has driven more interest in hedging. Earnings Forcing Themselves into Focus Earnings is perhaps the most immediate and broad catalyst for gamma. From a top down perspective the current earnings season does not seem to stir many strong feelings compared to previous reporting periods, but several of the few large names to report so far have seen significant volatility. This fits with the sentiment leading into 2Q09 results earnings and more importantly guidance matter, but more on a single-stock level than for the market overall. With DELL down 8% and INTC up 7% post earnings this low correlation view could have legs, even though pricing has not yet moved in that direction. With this backdrop it is important to keep in mind what may drive volatility as the bulk of companies come up for reporting in the coming weeks. Following on a respectable 1Q09 earnings season that was driven largely by stronger than expected margins, our macro team believes top line growth will need to materialize, or at least be visible in the near future, to justify further equity upside. With 3Q09 expected to be the bottom in earnings a pick up in visibility is key, as earnings estimates remain widely dispersed and a reduction of this uncertainty is key to lowering risk premiums and raising the multiple investors are willing to pay for stocks. Source: Morgan Stanley Research, FactSet Still Like Gamma Despite plenty of macro headlines and company announcements, as well as a big 1Q09 earnings seasons from financials, gamma has not been a money making trade in Volatility has fallen notably from its Nov 2008 highs, and even the recent move up and down in front-month volatility has not been enough to create meaningfully gamma profits (at the index level). We believe this trend could very well continue as both long and short-dated implied volatility grind lower as we work through a recovery - declining realized volatility will put pressure on the front end of the curve, while falling systemic risk and expectations for eventual recovery will weigh on the backend. We continue to recommend long gamma positions despite these headwinds, however. Exhibit 3 Gamma Not Paying Off 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Difference (RA) Previous Implied 1m Realized Feb-08 Mar-08 Apr-08 May-08 Jun-08 Jul-08 Aug-08 Sep-08 Oct-08 Nov-08 Dec-08 Jan-09 Feb-09 Mar-09 Apr-09 May-09 Jun-09 Jul-09 Source: Morgan Stanley Research, Morgan Stanley Quantitative and Derivative Strategies 60% 50% 40% 30% 20% 10% 0% -10% -20% -30% 3

4 Why buy gamma in a falling volatility environment? For portfolios set up for recovery, whether they be bullishly biased or long / short to play the cyclicality of recovery (implicitly short correlation), owning gamma makes sense as a hedge. Any recovery will inevitably have hiccups, driven by any of the potential events listed above. With plenty of room for corrections along the way, we think owning gamma either directly or through directional strategies offers more attractive risk reward at current prices than playing for a fall in volatility. Gamma and the VIX While gamma might seem like a very derivative centric concept, the most popular index measuring the options market does indeed measure gamma. Gamma is really just a fancy word for exposure to realized volatility. Near-term options, which the VIX measures on a rolling 30-day basis, are typically purchased to profit from either variability in the underlying (via delta-hedging) or large directional moves given the low cost and high convexity of short-dated options (more on this below). With such little time to expiration, they are typically not traded to take a view on implied volatility, as the P/L exposure to any change implied volatility (vega) is relatively low. To start with, a better understanding of what goes into the VIX can help improve its use as a market barometer, as well as the trading opportunities it offers. Very simply, the VIX is a weighted average of options of all strikes for the next two months, interpolated to give a constant 30-day measure. The VIX weighting scheme is the same that is used for variance swaps, and a discussion of how variance swaps are priced can shed some light on what the VIX really means. Variance swaps are the market s expectation for future volatility over all price scenarios of the underlying, instead of just around the region of the strike price that single options largely take into account. As such, pricing for variance and the VIX are based on all options of a given maturity across the full skew curve, and VIX will always be higher than the 1-month ATM volatility number given the impact of higher-volatility puts on the calculation (as well as other factors like the convexity of variance to volatility). As skew steepens, this gap will widen. Importantly, as the spot price declines and ATM volatilities naturally roll down the skew curve, the weights of the options that factor into the VIX calculation change, and VIX will increase, even if the volatilities of specific options have shown no change (although they often do as spot prices move). As a result variance swaps can hide what is going on in the underlying market just as much as ATM volatilities can, and it is important to look at changes in skew and changes in fixed-strike implied volatility to understand just what type of expectations are truly changing in the market. Exhibit 4 Volatility More than just ATM 30-day fixed strike volatility versus shifting ATM measure 65% 60% 55% 50% 45% 40% 35% 30% 25% 20% 1/2/09 1/16/09 1/30/09 2/13/09 2/27/09 3/13/09 3/27/09 4/10/09 4/24/09 5/8/ ATM Source: Morgan Stanley Research, Morgan Stanley Quantitative and Derivative Strategies Another layer to consider when looking at VIX is the impact of correlation. Like any other index volatility product, the implied correlation between stocks in the S&P 500 materially impacts the VIX level between August 22 and November 20, the rise in implied correlation contributed to 35% of the rise in ATM index volatility. With correlation normally correlated itself to the level of single-stock volatility the VIX is still useful as a measure of how underlying volatilities are changing, but can overstate the moves in component volatilities. Options on Options Because of its popularity, many in the market have some intuition and views on the range of the VIX. But it is also important to note that many investors not only watch the VIX, but actually trade it (through futures and even options 1 ), and these trades can make sense in certain environments. In our view, options on the VIX offer interesting payoffs, as optionality on volatility is something not readily available in other forms. Fundamentally, VIX options fit our view of the various gamma scenarios: our baseline view is for a grind lower, so limiting the loss from going long gamma by buying an option on it makes some sense, and given the potential for the VIX to spike such a position can offer a highly convex payoff should market sentiment deteriorate further (note that VIX skew is inverted, so at least partially prices this in). 1 The VIX itself cannot be traded, but futures and options that settle to the VIX are available. Note that VIX futures are not bound by cash and carry arbitrage given the VIX cannot be bought or sold, so can move independently of the VIX in theory, but in practice follow expected pricing patterns (correlated to the VIX, but with lower volatility, as we see for longer-dated variance swaps). Options in turn price off the futures, so daily mark-to-market may not be as extreme as if they priced to the VIX directly. 5/22/09 6/5/09 6/19/09 7/3/09 4

5 But when we look to the pricing of outright calls on the VIX, breakevens feel a bit high to us. The futures curve is very steep, with August VIX futures of ~29 currently 3 volatility points over the VIX itself, and just OTM options (~32.5 strike) carry breakevens near 35. It is also important to note that the VIX price process is highly non-normal given the potential for spikes, and although the volatility of volatility is the key input there are no simple models to describe and price it. As a result it is hard to say what is rich and cheap over time, and trading decisions need to rely more on a good intuition or scenario analysis. Gamma for the Everyman Exposure to the VIX is well and good for those taking a punt or hedging systemic risk, but for those looking for more direct protection on their positions gamma is better bought in vanilla puts and calls, in our view. Long gamma is really a hedge against gap risk, where a portfolio or stock moves faster than a manager can adjust for. As such buying puts and calls on the underliers at risk is the most direct way to manage directional exposure in a convex way. With correlation still pricing rich and due for a decline in our view (A Call on Declining Correlation, June 9, 2009), this can make single-name options the right place to buy gamma. As mentioned above, short-dated options have the most gamma exposure. For directional users of options, what this means is that short-dated options offer the most convex payoffs, and therefore the most profit on large moves in the underlier. To give an example, buying a 1-month ATM put at 30% volatility followed by a 5% move in the underlier drives a gain of 2.8% of notional, while the same move on a 1-year option only drives a gain of 2.2% of notional. On top of the stronger P/L response, short-dated options also come at lower cost than longer-dated. The tradeoff is of course that short-dated options do not offer protection over a broad swath of time. We are comfortable with this tradeoff though given our view that volatility will likely decline over time, with potentially lower options prices in the future offsetting the high theta cost of rolling the trade. Exhibit 5 Menu of Sector Option Prices Sector Option Pricing 1m Expiry Mids 97.5% Put 90/97.5% PS 102.5% Call 102.5/110% CS S&P % 1.4% 1.5% 1.4% Consumer Discretionary 2.5% 1.7% 2.3% 1.9% Consumer Staples 1.1% 0.9% 0.8% 0.8% Energy 2.8% 1.9% 2.7% 2.1% Financials 3.9% 2.2% 3.9% 2.4% Healthcare 1.5% 1.2% 1.3% 1.2% Industrials 2.6% 1.7% 2.4% 2.0% Materials 2.7% 1.8% 2.5% 2.0% Utilities 1.4% 1.2% 1.3% 1.3% TMT 1.9% 1.5% 1.8% 1.6% Source: Morgan Stanley Research, Morgan Stanley Quantitative and Derivative Strategies In June we highlighted our preference for setting 3 to 6-month hedges on sectors and single-names given our expectation for correlation to fall (Hedging Hangover, Jun 23, 2009). Below we apply that theme to nearer-dated options, where low volatilities and very steep curves in the front few months make 1-month option premiums relatively attractive in our view. For some sectors put and call spreads make sense (Financials and Energy show the greatest savings), but for the majority of the universe 1-month implied volatility (comparable to the VIX at ~26) is now low enough to justify outright option purchases. Realized volatility is picking up, in part due to the large close-to-close moves higher this week, and 1-month volatility appears to be bumping against a realized volatility floor. At this point, it seems aggressive for implied volatility to price well below realized. We also note that our core view of long gamma / short vega provides some cover if markets continue to heal and the entire volatility curve shifts lower. Strategy Risk Factors. For puts, calls, put spreads, or call spreads, the maximum potential loss is the premium paid. 5

6 Global Trade Ideas Trade Type Trade Reasoning Reference Reports NORTH AMERICA 1M puts & calls to hedge gap risk For investors either long or short risky assets, we favor buying gamma on the sector and single-name 7/15/ Keeping One Eye on the VIX levels, hedging gap risk over earnings season and other potential catalysts such as a pause in the healing credit market or QE exit strategies. Technology call calendar spreads and put spreads For those fully invested in the sector, near-dated put spreads are a good hedge against near-term economic headwinds or delayed PC upgrade cycle. For those looking to play timing of the upgrade cycle, we like long mid-2010 OTM calls to capture an earnings rebound funded by the sale of neardated OTM calls given already bullish sentiment. 7/8/ Timing the Tech Cycle Correlation Sector outperformance options We like pair trades via outperformance options as correlations are high and there could be return divergence in an uneven recovery. We like Energy over SPX & Cyclicals over Defensives outright, and SPX over RTY to hedge small cap exposure. We like Technology over Discretionary as a market neutral way to play the Enterprise IT equipment upgrade cycle and relative consumer weakness. 7/8/ Timing the Tech Cycle 6/9/ A Call on Declining Correlation 3M puts, put spreads, calls & call spreads on sectors Volatility Buy SPX 6m variance, Sell Variance For those positioned for range-bound moves, we like hedging outside the ranges, and use +/-10% as 6/23/ Hedging Hangover the definition of this range and +/-25% as a tail worth selling to help fund options. In a world where correlation is still high but should fall over time, setting up sector hedges that are aligned with portfolio tail risk makes sense to us. We like owning shorter-dated volatility in equity markets paired with the sale of longer-dated volatility 6/16/ Re-Risking and Recovery (timed for recovery). We believe this positioning makes sense today given both relatively flat (or 5/12/ Equities and the QE Quandary upward sloping) equity volatility curves and oustanding risks as the US works through a tepid recovery and exiting QE. Long S&P dividends; High rates or inflation is bad for P/Es, with dividends a better bullish play in a high inflation enviroment. Long S&P dividend S&P 500 dividend swap markets currently imply nearly flat earnings growth through 2012/4 maturities swap steepner using a 35% payout ratio, and we like dividends outright and steepners. Put / call spreads on Financials to hedge sector allocation bets For benchmarked investors, large-cap financials will likely define out- or under-performance for We believe volatility is now low enough to hedge sector underweights or overweights using put spreads, call spreads, call spread collars and up-and-in calls. Diagonal put spreads on S&P 500 We would use the flat term structure to reduce hedging costs by selling longer-dated further OTM puts to fund shorter-dated less OTM puts. The position is similar to a put spread, but with less upside potential on sell-offs, in exchange for less downside exposure on a market rally. Risk reversals on Russell 2000 We are somewhat cautious on small-caps given dependence on high yield credit market openness, which is still in its early days. Buy OTM puts on RTY, funded with the sale of OTM calls on either RTY or SPX. The latter retains potential small-cap outperformance in a rally. Put spreads to hedge Near-term market risks remain but tail risks have declined, and we like selling OTM puts as a funding mechanism for closer to the money protection despite flatter skew. EUROPE Long Healthcare / short Staples puts; Long Healthcare services / short Healthcare products options Uncertainty during the Healthcare reform debate is likely to drive volatility in We like owning healthcare puts funded by selling consumer staples puts as a sector rotation trade, and owning options on healthcare services names funded by selling options on products names. 3M 95% 80% put spreads on SX5E Due to the decline in implied volatility and the continued skew steepness we recommend investors hedge with 3M SX5E put spreads over the upcoming earnings season. 12M 95% 80% 115% put spread collars on SX5E For longer-dated hedging of long positions we recommend 1Y put spread collars. Put spread collars have high negative deltas and if overlaid over a long index position protect the underlying between the put strikes, but cap upside at the call strike. We recommend closing the short call strike in a market retracement, leaving a more levered put spread. 6/2/ Dividend Discovery 5/19/ Banking on Beta 5/12/ Equities and the QE Quandary 4/28/ Trading Uncertainty Over Time 5/5/ Small Cap Separation 4/21/ The Tails are Thinning 4/7/ A Few Healthcare Options 06/29/ Tactical Index Hedging and Sector Strategies in Europe 06/29/ Tactical Index Hedging and Sector Strategies in Europe SXKP 3M 105% 115% call spreads The Telecom sector is up only 1.3% over the past 3M, looks attractive on valuation grounds and underperformed the market and other defensive sectors. The MS strategy team rates Telecoms as 06/29/ Tactical Index Hedging and Sector Strategies in Europe their second largest Overweight and the weighted MS price target upside for the SXKP is 38.5% with a 94% coverage. Call spreads provide highly leveraged upside exposure while limiting the risks to the premium outlay. Alternatively investors should consider a delta 1 pair trade with the SX3P. SX3P 3M 95% 85% 107% put The Food and Beverage sector is up 14.4% over the past 3M, looks rich on valuation grounds and our 06/29/ Tactical Index Hedging and spread collars strategists rate the sector as their second largest underweight. The weighted MS price target upside Sector Strategies in Europe for the SX3P is 8.6% with a 90% coverage. We recommend to protect long positions with put spread collars. Alternatively investors should consider a delta 1 pair trade with the SXKP. Long SX5E dividend swaps, Long SX5E dividend swap steepener Long FTSE dividend swaps; Long FTSE dividend swap steepener The market is assuming a deeper and longer downturn than normal. MS Research bottom - up cash dividend estimates indicate that even in the bear case the peak to trough dividend decline of 46% is better than the market currrently expects. The flat term structure is highly unusual compared to historic dividend growth pattens following the cash market trough and realized dividend patterns. Bottom-up MS Research cash dividend estimates indicate the peak to trough dividend decline in the base case is 12%. Even in the bear case scenario, dividends would not fall more than 29%. The current FTSE dividend swap term structure is very flat, implying only very modest growth following the sharp peak to trough fall. We believe this is pessimistic and inconsistent with historic dividend growth patterns following the trough in dividend levels. Diagonal put spreads on the DAX We would use the flat term structure to reduce hedging costs by selling longer-dated further OTM puts to fund shorter-dated less OTM puts. We like selling the further OTM put at the market trough in March09, which should be an attractive entry level. The DAX has a high 66% weight in Financials and Cyclicals, which have rallied hard from the trough. / Single Name Options Dashboard Volatility ASIA & AUSTRALIA Correlation "Call versus call" structure on HSCI and NKY We suggest using the weekly Option Dashboard in conjunction with upcoming catalysts to identify potential volatility or directional intra sector opportunities in the single name option space. We believe the current high levels of index correlations in Asia are set to fall over the coming months. Less market focus on tail risk should lead to idiosyncratic issues taking over investors' attention and hence performance of indices should diverge as a result. Diagonal put spreads on ASX200 We like owning short- to medium-dated volatility (timed for QE exit if possible), paired with the sale of longer-dated volatility (timed for recovery). This positioning makes sense given somewhat upward sloping equity volatility curves and the risks associated with QE and its exit. Volatility Long ASX200 short-dated variance / short long-dated variance We like owning short- to medium-dated volatility (timed for QE exit if possible), paired with the sale of longer-dated volatility (timed for recovery). This positioning makes sense given somewhat upward sloping equity volatility curves and the risks associated with QE and its exit. Note: For a detailed discussion of strategy risk factors, please refer to the latest relevant published research 05/25/ SX5E Dividends Still Attractive Following the Rally 2/10/ FTSE Dividends Look Cheap 5/12/ Equities and the QE Quandary 2/25/ Single Name Option Dashboard 6/9/ A Call on Declining Correlation 5/12/ Equities and the QE Quandary 5/12/ Equities and the QE Quandary 6

7 Options Disclaimer Options are not for everyone. Before engaging in the purchasing or writing of options, investors should understand the nature and extent of their rights and obligations and be aware of the risks involved, including the risks pertaining to the business and financial condition of the issuer and the underlying stock. A secondary market may not exist for these securities. For customers of Morgan Stanley & Co. Incorporated who are purchasing or writing exchange-traded options, your attention is called to the publication Characteristics and Risks of Standardized Options; in particular, the statement entitled Risks of Option Writers. That publication, which you should have read and understood prior to investing in options, can be viewed on the Web at the following address: Spreading may also entail substantial commissions, because it involves at least twice the number of contracts as a long or short position and because spreads are almost invariably closed out prior to expiration. Potential investors should be advised that the tax treatment applicable to spread transactions should be carefully reviewed prior to entering into any transaction. Also, it should be pointed out that while the investor who engages in spread transactions may be reducing risk, he is also reducing his profit potential. The risk/ reward ratio, hence, is an important consideration. The risk of exercise in a spread position is the same as that in a short position. Certain investors may be able to anticipate exercise and execute a "rollover" transaction. However, should exercise occur, it would clearly mark the end of the spread position and thereby change the risk/reward ratio. Due to early assignments of the short side of the spread, what appears to be a limited risk spread may have more risk than initially perceived. An investor with a spread position in index options that is assigned an exercise is at risk for any adverse movement in the current level between the time the settlement value is determined on the date when the exercise notice is filed with OCC and the time when such investor sells or exercises the long leg of the spread. Other multiple-option strategies involving cash settled options, including combinations and straddles, present similar risk. Important Information: Examples within are indicative only, please call your local Morgan Stanley Sales representative for current levels. By selling an option, the seller receives a premium from the option purchaser, and the purchase receives the right to exercise the option at the strike price. If the option purchaser elects to exercise the option, the option seller is obligated to deliver/purchase the underlying shares to/from the option buyer at the strike price. If the option seller does not own the underlying security while maintaining the short option position (naked), the option seller is exposed to unlimited market risk. Spreading may entail substantial commissions, because it involves at least twice the number of contracts as a long or short position and because spreads are almost invariably closed out prior to expiration. Potential investors should carefully review tax treatment applicable to spread transactions prior to entering into any transactions. Multi-legged strategies are only effective if all components of a suggested trade are implemented. Investors in long option strategies are at risk of losing all of their option premiums. Investors in short option strategies are at risk of unlimited losses. There are special risks associated with uncovered option writing which expose the investor to potentially significant loss. Therefore, this type of strategy may not be suitable for all customers approved for options transactions. The potential loss of uncovered call writing is unlimited. The writer of an uncovered call is in an extremely risky position, and may incur large losses if the value of the underlying instrument increases above the exercise price. As with writing uncovered calls, the risk of writing uncovered put options is substantial. The writer of an uncovered put option bears a risk of loss if the value of the underlying instrument declines below the exercise price. Such loss could be substantial if there is a significant decline in the value of the underlying instrument. Uncovered option writing is thus suitable only for the knowledgeable investor who understands the risks, has the financial capacity and willingness to incur potentially substantial losses, and has sufficient liquid assets to meet applicable margin requirements. In this regard, if the value of the underlying instrument moves against an uncovered writer s options position, the investor s broker may request significant additional margin payments. If an investor does not make such margin payments, the broker may liquidate stock or options positions in the investor s account, with little or no prior notice in accordance with the investor s margin agreement. For combination writing, where the investor writes both a put and a call on the same underlying instrument, the potential risk is unlimited. If a secondary market in options were to become unavailable, investors could not engage in closing transactions, and an option writer would remain obligated until expiration or assignment. The writer of an American-style option is subject to being assigned an exercise at any time after he has written the option until the option expires. By contrast, the writer of a European-style option is subject to exercise assignment only during the exercise period. 7

8 Disclosure Section The information and opinions in Morgan Stanley Research were prepared or are disseminated by Morgan Stanley & Co. Incorporated and/or Morgan Stanley C.T.V.M. S.A. and/or Morgan Stanley & Co. International plc and/or Morgan Stanley Japan Securities Co., Ltd. and/or Morgan Stanley Asia Limited and/or Morgan Stanley Asia (Singapore) Pte. (Registration number Z) and/or Morgan Stanley Asia (Singapore) Securities Pte Ltd (Registration number H) and/or Morgan Stanley Taiwan Limited and/or Morgan Stanley & Co International plc, Seoul Branch, and/or Morgan Stanley Australia Limited (A.B.N , holder of Australian financial services license No , which accepts responsibility for its contents), and/or Morgan Stanley Smith Barney Australia Pty Ltd (A.B.N , holder of Australian financial services license No , which accepts responsibility for its contents), and/or Morgan Stanley India Company Private Limited and their affiliates (collectively, "Morgan Stanley"). As used in this disclosure section, Morgan Stanley includes RMB Morgan Stanley (Proprietary) Limited, Morgan Stanley & Co International plc and its affiliates. For important disclosures, stock price charts and rating histories regarding companies that are the subject of this report, please see the Morgan Stanley Research Disclosure Website at or contact your investment representative or Morgan Stanley Research at 1585 Broadway, (Attention: Equity Research Management), New York, NY, USA. Analyst Certification The following analysts hereby certify that their views about the companies and their securities discussed in this report are accurately expressed and that they have not received and will not receive direct or indirect compensation in exchange for expressing specific recommendations or views in this report: Sivan Mahadevan. Unless otherwise stated, the individuals listed on the cover page of this report are research analysts. Global Research Conflict Management Policy Morgan Stanley Research has been published in accordance with our conflict management policy, which is available at Important US Regulatory Disclosures on Subject Companies The research analysts, strategists, or research associates principally responsible for the preparation of Morgan Stanley Research have received compensation based upon various factors, including quality of research, investor client feedback, stock picking, competitive factors, firm revenues and overall investment banking revenues. Certain disclosures listed above are also for compliance with applicable regulations in non-us jurisdictions. STOCK RATINGS Morgan Stanley uses a relative rating system using terms such as Overweight, Equal-weight, Not-Rated or Underweight (see definitions below). Morgan Stanley does not assign ratings of Buy, Hold or Sell to the stocks we cover. Overweight, Equal-weight, Not-Rated and Underweight are not the equivalent of buy, hold and sell. Investors should carefully read the definitions of all ratings used in Morgan Stanley Research. In addition, since Morgan Stanley Research contains more complete information concerning the analyst's views, investors should carefully read Morgan Stanley Research, in its entirety, and not infer the contents from the rating alone. In any case, ratings (or research) should not be used or relied upon as investment advice. An investor's decision to buy or sell a stock should depend on individual circumstances (such as the investor's existing holdings) and other considerations. Global Stock Ratings Distribution (as of June 30, 2009) For disclosure purposes only (in accordance with NASD and NYSE requirements), we include the category headings of Buy, Hold, and Sell alongside our ratings of Overweight, Equal-weight, Not-Rated and Underweight. Morgan Stanley does not assign ratings of Buy, Hold or Sell to the stocks we cover. Overweight, Equal-weight, Not-Rated and Underweight are not the equivalent of buy, hold, and sell but represent recommended relative weightings (see definitions below). To satisfy regulatory requirements, we correspond Overweight, our most positive stock rating, with a buy recommendation; we correspond Equal-weight and Not-Rated to hold and Underweight to sell recommendations, respectively. Coverage Universe Investment Banking Clients (IBC) % of % of % of Rating Stock Rating Category Count Total Count Total IBC Category Overweight/Buy % % 32% Equal-weight/Hold % % 28% Not-Rated/Hold 31 1% 7 1% 23% Underweight/Sell % 87 14% 18% Total 2, Data include common stock and ADRs currently assigned ratings. An investor's decision to buy or sell a stock should depend on individual circumstances (such as the investor's existing holdings) and other considerations. Investment Banking Clients are companies from whom Morgan Stanley or an affiliate received investment banking compensation in the last 12 months. Analyst Stock Ratings Overweight (O or Over) - The stock's total return is expected to exceed the total return of the relevant country MSCI Index or the average total return of the analyst's industry (or industry team's) coverage universe, on a risk-adjusted basis over the next months. Equal-weight (E or Equal) - The stock's total return is expected to be in line with the total return of the relevant country MSCI Index or the average total return of the analyst's industry (or industry team's) coverage universe, on a risk-adjusted basis over the next months. Not-Rated (NR) - Currently the analyst does not have adequate conviction about the stock's total return relative to the relevant country MSCI Index or the average total return of the analyst's industry (or industry team's) coverage universe, on a risk-adjusted basis, over the next months. Underweight (U or Under) - The stock's total return is expected to be below the total return of the relevant country MSCI Index or the average total return of the analyst's industry (or industry team's) coverage universe, on a risk-adjusted basis, over the next months. Unless otherwise specified, the time frame for price targets included in Morgan Stanley Research is 12 to 18 months. Analyst Industry Views Attractive (A): The analyst expects the performance of his or her industry coverage universe over the next months to be attractive vs. the relevant broad market benchmark, as indicated below. In-Line (I): The analyst expects the performance of his or her industry coverage universe over the next months to be in line with the relevant broad market benchmark, as indicated below. Cautious (C): The analyst views the performance of his or her industry coverage universe over the next months with caution vs. the relevant broad market benchmark, as indicated below. 8

9 Benchmarks for each region are as follows: North America - S&P 500; Latin America - relevant MSCI country index or MSCI Latin America Index; Europe - MSCI Europe; Japan - TOPIX; Asia - relevant MSCI country index.. Important Disclosures for Morgan Stanley Smith Barney LLC Customers Citi Investment Research & Analysis (CIRA) research reports may be available about the companies that are the subject of this Morgan Stanley research report. Ask your Financial Advisor or use Research Center to view any available CIRA research reports in addition to Morgan Stanley research reports. In addition to the disclosures on this research report and on the Morgan Stanley disclosure website ( important disclosures regarding the relationship between the companies that are the subject of this report and Morgan Stanley Smith Barney LLC, Citigroup Global Markets Inc. or any of its affiliates, are available at This Morgan Stanley research report has been reviewed and approved on behalf of Morgan Stanley Smith Barney LLC. This review and approval was conducted by the same person who reviewed this research report on behalf of Morgan Stanley. This could create a conflict of interest. Other Important Disclosures Morgan Stanley produces a research product called a "Tactical Idea." Views contained in a "Tactical Idea" on a particular stock may be contrary to the recommendations or views expressed in this or other research on the same stock. This may be the result of differing time horizons, methodologies, market events, or other factors. For all research available on a particular stock, please contact your sales representative or go to Client Link at For a discussion, if applicable, of the valuation methods used to determine the price targets included in this summary and the risks related to achieving these targets, please refer to the latest relevant published research on these stocks. Morgan Stanley Research does not provide individually tailored investment advice. Morgan Stanley Research has been prepared without regard to the individual financial circumstances and objectives of persons who receive it. The securities/instruments discussed in Morgan Stanley Research may not be suitable for all investors. Morgan Stanley recommends that investors independently evaluate particular investments and strategies, and encourages investors to seek the advice of a financial adviser. The appropriateness of a particular investment or strategy will depend on an investor's individual circumstances and objectives. The securities, instruments, or strategies discussed in Morgan Stanley Research may not be suitable for all investors, and certain investors may not be eligible to purchase or participate in some or all of them. Morgan Stanley Research is not an offer to buy or sell or the solicitation of an offer to buy or sell any security/instrument or to participate in any particular trading strategy. The "Important US Regulatory Disclosures on Subject Companies" section in Morgan Stanley Research lists all companies mentioned where Morgan Stanley owns 1% or more of a class of common securities of the companies. For all other companies mentioned in Morgan Stanley Research, Morgan Stanley may have an investment of less than 1% in securities or derivatives of securities of companies and may trade them in ways different from those discussed in Morgan Stanley Research. Employees of Morgan Stanley not involved in the preparation of Morgan Stanley Research may have investments in securities or derivatives of securities of companies mentioned and may trade them in ways different from those discussed in Morgan Stanley Research. Derivatives may be issued by Morgan Stanley or associated persons Morgan Stanley and its affiliate companies do business that relates to companies/instruments covered in Morgan Stanley Research, including market making and specialized trading, risk arbitrage and other proprietary trading, fund management, commercial banking, extension of credit, investment services and investment banking. Morgan Stanley sells to and buys from customers the securities/instruments of companies covered in Morgan Stanley Research on a principal basis. With the exception of information regarding Morgan Stanley, research prepared by Morgan Stanley Research personnel are based on public information. Morgan Stanley makes every effort to use reliable, comprehensive information, but we make no representation that it is accurate or complete. We have no obligation to tell you when opinions or information in Morgan Stanley Research change apart from when we intend to discontinue research coverage of a subject company. Facts and views presented in Morgan Stanley Research have not been reviewed by, and may not reflect information known to, professionals in other Morgan Stanley business areas, including investment banking personnel. Morgan Stanley Research personnel conduct site visits from time to time but are prohibited from accepting payment or reimbursement by the company of travel expenses for such visits. The value of and income from your investments may vary because of changes in interest rates or foreign exchange rates, securities prices or market indexes, operational or financial conditions of companies or other factors. There may be time limitations on the exercise of options or other rights in your securities transactions. Past performance is not necessarily a guide to future performance. Estimates of future performance are based on assumptions that may not be realized. Unless otherwise stated, the cover page provides the closing price on the primary exchange for the subject company's securities/instruments. To our readers in Taiwan: Information on securities/instruments that trade in Taiwan is distributed by Morgan Stanley Taiwan Limited ("MSTL"). Such information is for your reference only. Information on any securities/instruments issued by a company owned by the government of or incorporated in the PRC and listed in on the Stock Exchange of Hong Kong ("SEHK"), namely the H-shares, including the component company stocks of the Stock Exchange of Hong Kong ("SEHK")'s Hang Seng China Enterprise Index; or any securities/instruments issued by a company that is 30% or more directly- or indirectly-owned by the government of or a company incorporated in the PRC and traded on an exchange in Hong Kong or Macau, namely SEHK's Red Chip shares, including the component company of the SEHK's China-affiliated Corp Index is distributed only to Taiwan Securities Investment Trust Enterprises ("SITE"). The reader should independently evaluate the investment risks and is solely responsible for their investment decisions. Morgan Stanley Research may not be distributed to the public media or quoted or used by the public media without the express written consent of Morgan Stanley. Information on securities/instruments that do not trade in Taiwan is for informational purposes only and is not to be construed as a recommendation or a solicitation to trade in such securities/instruments. MSTL may not execute transactions for clients in these securities/instruments. To our readers in Hong Kong: Information is distributed in Hong Kong by and on behalf of, and is attributable to, Morgan Stanley Asia Limited as part of its regulated activities in Hong Kong. If you have any queries concerning Morgan Stanley Research, please contact our Hong Kong sales representatives. Certain information in Morgan Stanley Research was sourced by employees of the Shanghai Representative Office of Morgan Stanley Asia Limited for the use of Morgan Stanley Asia Limited. Morgan Stanley Research is disseminated in Japan by Morgan Stanley Japan Securities Co., Ltd.; in Hong Kong by Morgan Stanley Asia Limited (which accepts responsibility for its contents); in Singapore by Morgan Stanley Asia (Singapore) Pte. (Registration number Z) and/or Morgan Stanley Asia (Singapore) Securities Pte Ltd (Registration number H), regulated by the Monetary Authority of Singapore, which accepts responsibility for its contents; in Australia to "wholesale clients" within the meaning of the Australian Corporations Act by Morgan Stanley Australia Limited A.B.N , holder of Australian financial services license No , which accepts responsibility for its contents; in Australia to wholesale clients and "retail clients" within the meaning of the Australian Corporations Act by Morgan Stanley Smith Barney Australia Pty Ltd (A.B.N , holder of Australian financial services license No , which accepts responsibility for its contents; in Korea by Morgan Stanley & Co International plc, Seoul Branch; in India by Morgan Stanley India Company Private Limited; in Canada by Morgan Stanley Canada Limited, which has approved of, and has agreed to take responsibility for, the contents of Morgan Stanley Research in Canada; in Germany by Morgan Stanley Bank AG, Frankfurt am Main, regulated by Bundesanstalt fuer Finanzdienstleistungsaufsicht (BaFin); in Spain by Morgan Stanley, S.V., S.A., a Morgan Stanley group company, which is supervised by the Spanish Securities Markets Commission (CNMV) and states that Morgan Stanley Research has been written and distributed in accordance with the rules of conduct applicable to financial research as established under Spanish regulations; in the United States by Morgan Stanley & Co. Incorporated, which accepts responsibility for its contents. Morgan Stanley & Co. International plc, authorized and regulated by Financial Services Authority, disseminates in the UK research that it has prepared, and approves solely for the purposes of section 21 of the Financial Services and Markets Act 2000, research which has been prepared by any of its affiliates. Private U.K. investors should obtain the advice of their Morgan Stanley & Co. International plc representative about the investments concerned. RMB Morgan Stanley (Proprietary) Limited is a member of the JSE Limited and regulated by the Financial Services Board in South Africa. RMB Morgan Stanley (Proprietary) Limited is a joint venture owned equally by Morgan Stanley International Holdings Inc. and RMB Investment Advisory (Proprietary) Limited, which is wholly owned by FirstRand Limited. The information in Morgan Stanley Research is being communicated by Morgan Stanley & Co. International plc (DIFC Branch), regulated by the Dubai Financial Services Authority (the DFSA), and is directed at wholesale customers only, as defined by the DFSA. This research will only be made available to a wholesale customer who we are satisfied meets the regulatory criteria to be a client. The information in Morgan Stanley Research is being communicated by Morgan Stanley & Co. International plc (QFC Branch), regulated by the Qatar Financial Centre Regulatory Authority (the QFCRA), and is directed at business customers and market counterparties only and is not intended for Retail Customers as defined by the QFCRA. As required by the Capital Markets Board of Turkey, investment information, comments and recommendations stated here, are not within the scope of investment advisory activity. Investment advisory service is provided in accordance with a contract of engagement on investment advisory concluded between brokerage houses, portfolio management companies, non-deposit banks and clients. Comments and recommendations stated here rely on the individual opinions of the ones providing these 9

10 comments and recommendations. These opinions may not fit to your financial status, risk and return preferences. For this reason, to make an investment decision by relying solely to this information stated here may not bring about outcomes that fit your expectations. The trademarks and service marks contained in Morgan Stanley Research are the property of their respective owners. Third-party data providers make no warranties or representations of any kind relating to the accuracy, completeness, or timeliness of the data they provide and shall not have liability for any damages of any kind relating to such data. The Global Industry Classification Standard ("GICS") was developed by and is the exclusive property of MSCI and S&P. Morgan Stanley has based its projections, opinions, forecasts and trading strategies regarding the MSCI Country Index Series solely on publicly available information. MSCI has not reviewed, approved or endorsed the projections, opinions, forecasts and trading strategies contained herein. Morgan Stanley has no influence on or control over MSCI's index compilation decisions. Morgan Stanley Research, or any portion thereof may not be reprinted, sold or redistributed without the written consent of Morgan Stanley. Morgan Stanley Research is disseminated and available primarily electronically, and, in some cases, in printed form. Additional information on recommended securities/instruments is available on request. 10

11 The Americas Europe Japan Asia/Pacific 1585 Broadway 20 Bank Street, Canary Wharf Ebisu, Shibuya-ku 1 Austin Road West New York, NY United States London E14 4AD United Kingdom Tokyo Japan Kowloon Hong Kong Tel: +1 (1) Tel: +44 (0) Tel: +81 (0) Tel: Morgan Stanley