The recent sharp pullback in volatility as year-end approaches creates hedging opportunities given the cloudy outlook for equities, according to Goldman Sachs Group Inc. strategists.
Wall Street’s “fear gauge” — the VIX volatility index — last week hit the lowest since the coronavirus pandemic. But investors continue to weigh risks to the outlook, ranging from geopolitics, next year’s busy elections calendar and the potential for shocks on the economic growth front, the team led by Christian Mueller-Glissmann wrote in a note dated Nov. 27.
“After the recent equity rally, we believe there is an attractive entry point to hedge the risk of a retracement,” the strategists said.
They note that three-month put spreads on the the S&P 500 are trading close to all-time lows. For longer investment horizons, they like equity collars — a strategy where near at-the-money puts are financed by selling out-of-the-money calls.
Source: Goldman Sachs
The VIX declined to 12.45 last week, and has been hovering below the 13 level since. The drop in volatility has underpinned the rally in US stocks, with the S&P 500 up nearly 19% this year, after surging more than 10% in the past month alone.
“Cross-asset volatility has continued to reset lower, supported by markets further embracing the ‘inverse’ Goldilocks backdrop in the US with faster-than-expected inflation normalization and growth remaining resilient,” the strategists said. That drop has further widened the gap to rates volatility, which should normalize in 2024, they added.
In other potential hedging strategies, the Goldman strategists suggest hedging downside for euro-area banks, as implied volatility for the Euro Stoxx Bank Index (SX7E) is close to the lowest level since the global financial crisis, while gold volatility also looks interesting.
“We find SX7E puts attractive as a buffer against a rise in euro-area sovereign risk,” a resurgence in benchmark gas prices or a further deterioration in euro-area growth sentiment, they wrote. “Long gold volatility also looks attractive to hedge against an increase — or sudden decrease — in geopolitical risk.”
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