Investors looking to protect their stock market positions from a potential downturn may have an option without fully adjusting their exposure to equities. According to Goldman Sachs, there is a way to hedge against a market selloff by focusing on the Cboe Volatility Index, or “Vix.” Arun Prakash from Goldman’s derivatives research team suggests an options trade centered on the VIX to protect against potential stock market volatility.
The VIX, which measures the expected volatility of the S&P 500 based on options contracts, has been trading at unusually low levels, hovering around 14.40. Goldman’s model predicts the VIX could rise to 21.5 in April based on economic factors. The specific trade recommended by Prakash is to buy call options on the VIX with a strike price of 16 that expire in April.
While the VIX itself is not a security, options trades on the index are settled in cash. If the index were to reach its historical average in April, these call options would be “in the money.” Prakash points to upcoming macro and micro catalysts, such as the start of earnings season and the Federal Reserve meeting, as potential drivers of volatility.
It’s important to note that the VIX is not a direct hedge against a declining equity market, and it remained below its record highs during the market selloff in 2020. If the VIX does not exceed the strike price before the options contract expires, the trader would lose the premium paid for the contract.
Despite the uncertainties, Goldman Sachs believes that buying VIX calls could provide an attractive hedge in case of a pullback in equities. This strategy allows investors to potentially protect their positions without significantly adjusting their exposure to the stock market. While there are always risks involved with financial trades, employing this options strategy may provide some peace of mind for investors concerned about potential market reversals.
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