The global financial landscape could be on the brink of a significant upheaval, warns Goldman Sachs. While markets may appear calm and range-bound, investors are grappling with underlying macro-risk factors that are often overlooked. However, the potential for geopolitical tensions, ongoing central bank policies aimed at curbing inflation while avoiding economic downturns, and the looming threat of a U.S. government shutdown cannot be disregarded indefinitely.
According to John Marshall, Goldman's derivatives strategist, the apprehension surrounding risk could trigger a reevaluation, leading to a decline in stock prices and an uptick in options volatility. Marshall's analysis reveals that, on average, options volatility for the S&P 500 index has surged by 27% between August and October over the past 95 years. Additionally, data shows that October has consistently witnessed higher realized volatility compared to other months for the past 95 years for the S&P 500, and over the past four decades for the Nasdaq 100, Russell 1000, and Russell 2000 indexes.
In light of these findings, Goldman Sachs' strategy team has advised clients to approach options selling with caution—a strategy that has traditionally enjoyed popularity. The team cites seasonal volatility increases in October and a dense corporate calendar filled with earnings releases and other financial updates as reasons for their cautious stance.
During October, corporate management teams face mounting pressure to meet full-year earnings targets as time runs out. Similarly, investment managers are under immense scrutiny to deliver desired performance outcomes before the year concludes. Failure to impress during earnings reports, investor meetings, and financial guidance announcements can have severe repercussions for companies. Market volumes tend to reflect the intensity of investor reactions.
As we approach October, investors should remain vigilant and adjust their strategies accordingly. While the precise nature of the impending volatility remains uncertain, being prepared for potential market turbulence is essential.
The October Effect: A Strategy for Profit in Volatile Markets
In the world of finance, October has historically been a month of heightened market activity. Analysts have observed that shares and single stock options volumes tend to peak during this time, particularly in the fourth quarter.
Recognizing the potential for market disruption, experts are advising investors to consider hedging their portfolios against expected stock market weakness. One popular strategy recommended by Marshall, a prominent figure in the industry, is to buy October call options on the Cboe Volatility Index (VIX).
The VIX, although not directly traded, serves as a tracking index. Investors can profit from potential market chaos by buying VIX call options, often regarded as S&P 500 options on steroids. When the S&P 500 experiences a decline, the VIX, also known as the fear gauge, tends to increase. This has led to a rise in interest in VIX call options.
Alison Edwards, a respected strategist at Susquehanna Financial Group, advises clients on significant VIX "tail-risk hedging." Tail-risk hedges are low-cost trades that yield substantial returns if the stock market collapses. Recent trades have focused on VIX options that would increase in value if the VIX were to spike to $47.50 in March.
While portfolio hedging and VIX spikes dominate market discussions, Marshall predicts that trading in individual stocks will regain favor once investors regain confidence in central banks and their potential to stabilize interest rates.
Steven M. Sears is the president and chief operating officer of Options Solutions, a specialized asset-management firm. Neither he nor the firm has a position in the options or underlying securities mentioned in this column.