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May 20 11

Options on Dividends – An Introduction. Dr. Akilesh Eswaran akilesh.eswaran@db.com. May 20 11. Introduction. Options on Dividend Futures are a new listed product offered by Eurex since May 2010 Option on dividends are listed with annual expiries upto 2019

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May 20 11

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  1. Options on Dividends – An Introduction Dr.AkileshEswaran akilesh.eswaran@db.com May 2011

  2. Introduction • Options on Dividend Futures are a new listed product offered by Eurex since May 2010 • Option on dividends are listed with annual expiries upto 2019 • Number of strikes available vary by expiry with additional strikes listed for 2012, 2013 and 2014 • Contract value is EUR 100 per index dividend point of underlying Euro STOXX 50 Index Dividend Futures

  3. Contract Specification Option on Dividend Contract Specification

  4. Uses of Options on Dividends • Why trade options on dividends? • Leverage • Efficient hedge for portfolio risk • Exploit supply demand inefficiencies • Opportunities for relative value trading • Delta1 Overlay strategies

  5. Pricing Option on Dividends • Dividend Future is assumed to follow a Log-normal distribution, i.e. the same stochastic process as the index • Options on dividends can be priced using a Black Scholes Model assuming a Flat Forward • Value of a call option at time ‘t’ (C(S,t)) using a flat forward Black Scholes model is the following: • where, • N(x) is the cumulative distribution function of a standard normal distribution • S is the Spot Dividend • K is the Option Strike • T-t is the Time to Maturity • σ is the Volatility of dividend returns

  6. Volatility of Dividend Futures • The most important determinant of the option price is the volatility assumption • A key difference between dividend futures and equity index is that dividends realize. • Dividends while initially unknown are announced and paid. The fact that dividends become known has major implications for option pricing • Dividend realized volatility trend towards zero as the maturity of the future approaches • The dividends referenced by 2011 contract are paid from earnings accrued during the 2010 fiscal year. 3M Realized Volatility of Dec-11 Div Futures 3M Realized Volatility of Dec-14 Div Futures

  7. Historical Volatility of Dividend Futures • The dividends can be more volatile than the equity index during the period of market stress and when risk trades are unwound. Historical Implied vol of Dividends The ratio of Index vol to div vol approaches zero as the volatility of the dividend futures decline but it can be above the index volatility even during periods of relative calm such as summer 2009 3M Realized Volatility Ratio of Dec’11 Div to SX5E 3M Realized Volatility Ratio of Dec’14 Div to SX5E

  8. Beta of Dividend futures • The figure below shows the beta of dividend futures to the SX5E Index including only the days where the index moved by at least 2% (either up or down) • The important point to note is that the beta of dividend futures to the index itself has historically been higher on the downside than on the upside • This implies that Option on Dividends can be an attractive alternative to hedge downside risk Beta of Dec’14 Div vs. SX5E index for index moves > 2%

  9. Trading Dividends on other Indices • The most common way of trading dividends is buying Futures outright • E-STOXX 50 expected dividend growth is depressed compared to S&P 500 and FTSE • Macro and structural factors have pressured European implied growth • Nikkei 225 has a similar structured products overhang as the E-STOXX 50 • Difficult to play convergence due to wide bid/offer and limited liquidity on the S&P 500 dividend swaps Dividend Futures Source: DB estimates. Levels are as of 17-Nov-10

  10. Trading Dividends • Long E-STOXX 50 dividend futures for ‘safer’ equity exposure • Dividend contracts trade at a discount to estimates, div payments are typically more stable than equity prices • Consider buying dividend futures to maintain equity exposure with potentially less volatility than a long stock position • Contracts with varied maturities allow for speculation medium-to-long growth expectations • A long div futures position may incur material losses if implied or realized dividend decline (can use options instead) E-STOXX 50 Historical and Expected Dividend Growth Sources: DB , Bloomberg. *As of 17-Nov-10

  11. Trading Dividends – some trade ideas • Dec-12 Capped bullish risk reversal: Short 118 put, long 125 call, short 135 call for 0 premium. • - Pull to fair value of dividends expected in the next 6 to 8 months => quick Mark to market gains • Dec12 Short 118 put vs Long 127 call for zero premium • Short 2 X Dec12 118 puts to buy a Dec13 129 Call • - Dec13 dividends trade at around a 27% discount to analyst fair value estimates • Some other prices commonly traded structures on Option on Dividends: • Call/Put option • Zero Premium Bullish Risk Reversal: Client Sells OTM Put to Buy OTM Call • Zero Premium Call Spread Collar: Client Sells Put to buy Call Spread Ref Levels: Dec-12: 123, Dec 13: 117, Dec14: 113 10

  12. Trading Dividends – exotic options • Dividend/Spot Exotic Option • 2013 dividends offer a large discount compared to estimates and to last realized dividends • However, buying Dec 13 dividends outright can be risky as: • Implied dividends tend to fall even more than spot on the downside due to lower liquidity and market bias (most active players being long) • the longer the maturity the higher the uncertainty on the Dividend and the higher the downside risk • Furthermore buying a simple call on Dec 13 dividends can prove expensive compared to reasonable expected upside • In a weak recovery scenario we could keep seeing solid corporate profits of large caps and growing dividends… • ….while poor macro indicators, less leverage and high unemployment would prevent a strong market rally (SX5E already up 55% from the lowest level seen during credit crisis in March ‘09) • Indicative Terms • Idea • Maturity – Dec ’13 / Currency EUR • If SX5E does not hit 120% of its initial value (continuous observation) till Dec ‘12 • Client receives Max(0, Dec ‘13 Dividends – 117) • Else, 0% • Indicative offer at 9.0 vs. 12.0 on the vanilla call for ref 2013 Dividends at 117 SX5E Dividends – Futures vs. Analyst’s Estimates RISK : Investor might lose all the premium Please note that all levels provided in this presentation are indicative and forillustration purposes only.

  13. Deutsche Bank’s Dividend Research Offering

  14. An comprehensive dividend research offering from DB • An extensive library of dedicated dividend research. Recent publications & presentations include: • May-11: E-STOXX 50 Dec-12 Dividend Scenarios • Mar-11: Derivatives Monthly April – Dividend Season Trades • Feb-11: Dividends as an Asset Class • Sep-10: The fundamentals of dividend futures and The dynamics of dividend futures • Jul-10: The value in European dividends • Weekly E-STOXX 50, FTSE & SPX index dividend monitors • On-line dividend analysis tools • Bespoke analysis, including bottom-up and top-down forecasts • Database of European dividend news and estimate changes

  15. Dividend analysis available on-line at eDerivatives • Valuation: Plot historical actual dividend levels or dividend yields • Market dynamic: Plot rolling maturities or actual expiration • Sensitivity analysis: Check implied dividend volatility or its beta against market index • Cross asset: Compare dividend and bond yields across maturities • Implied growth: View market expectations for future dividend growth and compare implied growth rates among major indices The world of derivatives at http://eDerivatives.db.com

  16. Equities Derivatives Group - Europe London - Tel: +44 20 7547 1343 Frankfurt - Tel: +49 69 9103 8434 Akilesh Eswaran : akilesh.eswaran@db.com Contacts

  17. Disclaimer HYPOTHETICAL DISCLAIMER Backtested, hypothetical or simulated performance results discussed herein have inherent limitations. Unlike an actual performance record based on trading actual client portfolios, simulated results are achieved by means of the retroactive application of a backtested model itself designed with the benefit of hindsight. Taking into account historical events the backtesting of performance also differs from actual account performance because an actual investment strategy may be adjusted any time, for any reason, including a response to material, economic or market factors. The backtested performance includes hypothetical results that do not reflect the reinvestment of dividends and other earnings or the deduction of advisory fees, brokerage or other commissions, and any other expenses that a client would have paid or actually paid. No representation is made that any trading strategy or account will or is likely to achieve profits or losses similar to those shown. Alternative modeling techniques or assumptions might produce significantly different results and prove to be more appropriate. Past hypothetical backtest results are neither an indicator nor guarantee of future returns. Actual results will vary, perhaps materially, from the analysis. Acting at arm's length. Pricing levels and valuations published herein are indicative and they and any other information are for information purposes only. MARKETING MATERIAL This document is intended for discussion purposes only and does not create any legally binding obligations on the part of Deutsche Bank AG and/or its affiliates (“DB”). Without limitation, this document does not constitute an offer, an invitation to offer or a recommendation to enter into any transaction. When making an investment decision, you should rely solely on the final documentation relating to the transaction and not the summary contained herein. DB is not acting as your financial adviser or in any other fiduciary capacity with respect to this proposed transaction. The transaction(s) or products(s) mentioned herein may not be appropriate for all investors and before entering into any transaction you should take steps to ensure that you fully understand the transaction and have made an independent assessment of the appropriateness of the transaction in the light of your own objectives and circumstances, including the possible risks and benefits of entering into such transaction. For general information regarding the nature and risks of the proposed transaction and types of financial instruments please go to www.globalmarkets.db.com/riskdisclosures. You should also consider seeking advice from your own advisers in making this assessment. If you decide to enter into a transaction with DB, you do so in reliance on your own judgment. The information contained in this document is based on material we believe to be reliable; however, we do not represent that it is accurate, current, complete, or error free. Assumptions, estimates and opinions contained in this document constitute our judgment as of the date of the document and are subject to change without notice. Any projections are based on a number of assumptions as to market conditions and there can be no guarantee that any projected results will be achieved. Past performance is not a guarantee of future results. This material was prepared by a Sales or Trading function within DB, and was not produced, reviewed or edited by the Research Department. Any opinions expressed herein may differ from the opinions expressed by other DB departments including the Research Department. Sales and Trading functions are subject to additional potential conflicts of interest which the Research Department does not face. DB may engage in transactions in a manner inconsistent with the views discussed herein. DB trades or may trade as principal in the instruments (or related derivatives), and may have proprietary positions in the instruments (or related derivatives) discussed herein. DB may make a market in the instruments (or related derivatives) discussed herein. Sales and Trading personnel are compensated in part based on the volume of transactions effected by them. The distribution of this document and availability of these products and services in certain jurisdictions may be restricted by law. You may not distribute this document, in whole or in part, without our express written permission. DB SPECIFICALLY DISCLAIMS ALL LIABILITY FOR ANY DIRECT, INDIRECT, CONSEQUENTIAL OR OTHER LOSSES OR DAMAGES INCLUDING LOSS OF PROFITS INCURRED BY YOU OR ANY THIRD PARTY THAT MAY ARISE FROM ANY RELIANCE ON THIS DOCUMENT OR FOR THE RELIABILITY, ACCURACY, COMPLETENESS OR TIMELINESS THEREOF. DB is authorised under German Banking Law (competent authority: BaFin - Federal Financial Supervising Authority) and regulated by the Financial Services Authority for the conduct of UK business.

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