Hedge for a market decline

Investors worried that the stock market is due for a reversal may be able to hedge their position without changing their exposure to equities, according to Goldman Sachs. Arun Prakash from Goldman’s derivatives research team proposed an options trade focused on the Cboe Volatility Index , or “Vix,” to hedge against a market selloff. The volatility index appears to be too low, and there are several reasons to think that stocks and the VIX will spike over the next month, Prakash said in a note to clients on Thursday. “S & P 500 index skew is close to multi-year lows, indicating that the upside asymmetry is crowded, and we believe VIX calls would be an attractive hedge in case of a pullback in equities,” the note said. The Vix is an index that measures expected volatility of the S & P 500 in the month ahead based on the current price of various options contracts. The index, which was trading at roughly 14.40 on Thursday, has spent most of this year below 15 and hasn’t crossed 20 since November. That’s an unusually low level for the VIX, which spiked to a record high of about 85 during the Covid selloff in 2020. A Goldman model, based on several economic factors, projects the VIX will rise to 21.5 in April. .VIX 5Y mountain The Cboe Volatility Index has been trading at an unusually low level in 2024 so far. The specific trade highlighted by Prakash is to buy call options on the Cboe Volatility Index that expire in April and have a strike price of 16. Generally speaking, a call option gives the holder the right to buy the underlying asset at the strike price, and serves as a bet that the asset will rise above the strike price. Since the VIX itself is not a security, options trade on the index are settled in cash. The calls recommended by Prakash would be easily “in the money” if the index just jumped to its historical average for April, according to Goldman. “Over the past 30+ years, VIX has averaged 19 in April, and we see upside risks to the current low VIX levels given current macro environment and upcoming macro/micro catalysts. S & P 500 index skew is close to multi-year lows, indicating that the upside asymmetry is crowded, and we believe VIX calls would be an attractive hedge in case of a pullback in equities,” the note said. Some of those potential catalysts for volatility include the start of first-quarter earnings season, next week’s Federal Reserve meeting and the ramp up of news around the U.S. presidential election, according to Goldman. To be sure, the Vix is not a direct hedge against a falling equity market, and the index stayed well below its record highs during the steep market selloff in 2022. If the Vix does not rise above the strike price before the options contract expires, the trader loses the premium paid for the contract. — CNBC’s Michael Bloom contributed reporting.