“Hedge What You’re Afraid Of” – Goldman Urges Clients To Start Preparing For The Worst

Monday, April 2, 2018
By Paul Martin

by Tyler Durden
Mon, 04/02/2018

It’s time to start hedging.

That is the warning to clients from the latest report by Goldman’s derivative strategists John Marshall and Katherine Fogerty, who caution that in the aftermath of the February VIX spike, as volatility increases “so do returns from time invested in hedging strategies increase.”

As a result, Goldman has laid out a comprehensive framework for “identifying efficient portfolio hedges in the options market” focusing on methods that add alpha even as they reduce hedge costs and increase potential returns.

The main catalyst for the bank’s shift in outlook is the expectation that increases in realized volatility will force vol-targeting funds to adjust gross and net exposure, and lever appropriately, as well as have direct effects on the calculation of risk in a variety of equity portfolios (when volatility rises, position sizes need to decrease to maintain the same dollar-volatility risk). This is especially relevant for massive, risk-parity books, where the act of deleveraging itself can be destabilizing for risk. Goldman explains:

The spike in VIX and realized volatility was large enough for investors outside the equity market to take notice and could lead to a reduction in risk-taking appetite on the margin in the coming months. It was yet another symptom of the market fragility created by lower liquidity. We believe that a shift towards risk reduction and expectation of higher volatility is likely to change the trading dynamics in 2018 and increase the value of time spent on hedging.

The Rest…HERE

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