Investors should buy cheap portfolio insurance now before stock market turns volatile, Goldman warns

By José Adinolfi

The team recommended that clients buy short-term VIX calls ahead of a wave of risk events.

Calm markets are about to become volatile, so investors should take the opportunity to buy cheap portfolio insurance before it's too late, according to a team of Goldman Sachs strategists.

The team of derivatives strategists recommended buying calls linked to Cboe's VIX Volatility Index, which captures traders' expectations about how volatile markets could become in the immediate future. These contracts are the most profitable hedge against a potentially violent downward move next month, the team said.

Lately, activity in the options market has tilted heavily toward bullish call contracts as traders have chased a rally that has continued for nearly five months without a significant pullback.

This has helped suppress the price of bearish options like VIX calls, which typically pay off when markets drop suddenly, since implied volatility tends to rise more quickly when markets are falling.

"We believe VIX call options would be an attractive hedge in the event of an equity pullback," the Goldman team said.

A call option represents a bet that the underlying asset or index will rise, while a put option represents the opposite.

One source of inspiration for the recommendation, according to the team, is a Goldman model that shows a high probability that markets will experience a sudden sell-off over the next month, as traders have become complacent while major indices have diverged. further into record territory.

The Goldman team also sees next week's Nvidia Corp. (NVDA) investor day and the March meeting of Federal Reserve policymakers as two events that could potentially shake up markets.

A steady drumbeat of corporate earnings reports could also help drag stocks lower.

Macroeconomic events such as the release of economic data could also shake the markets, including upcoming inflation readings. An unexpected macroeconomic shock could send the VIX up as high as 28, the Goldman team said.

Reports on consumer and producer prices released earlier this week showed a sharper rise in February than economists expected. Election-related factors are also a risk.

Seasonal trends showing volatility generally increases in the spring added to Goldman's growing sense of unease. The VIX has averaged 19 in April over the past 30 years, according to the team led by the head of derivatives research at John Marshall Goldman. The index stood at 14.19 at the close on Thursday.

"We believe 1) [VIX] at a historically low level, 2) [S&P 500] near its all-time highs, 3) high demand for bullish asymmetry, 4) our model estimated the rise in [VIX] and 5) upcoming macro/micro catalysts offer a compelling argument for investors to own [VIX] calls," the strategists said.

For now, U.S. stocks remain near all-time highs, although some weakness has crept into markets recently, and major U.S. stock indexes finished lower last week for the third time in the past four and a half months, according to data. by FactSet.

The S&P 500 SPX fell for the second straight day on Thursday, losing 14.83 points, or 0.3%, to finish at 5,150.48, the index's fourth-highest close on record, according to Dow Jones Market Data.

The Dow Jones Industrial Average DJIA lost 137.66 points, or 0.35%, to end Thursday at 38905.66. The Nasdaq Composite COMP fell 49.24 points, or 0.3%, to 16,128.53.

-Jose Adinolfi

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03-15-24 0949ET

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