(Bloomberg) -- Equity volatility is elevated but options trading shows investors’ appetite for protection hasn’t picked up, indicating hedging is needed, according to Goldman Sachs Group Inc (NYSE:GS).
Strategists led by John Marshall observed that “a large number” of S&P 500 hedges expired over the past three weeks, leaving the average investor more exposed to stock swings. Meanwhile, the Cboe Volatility Index almost doubled in the first quarter as concerns over global trade tensions and the Federal Reserve’s monetary policy stirred up market turbulence. The options gauge, known as VIX, jumped 20 percent to 23.89 as of 12:11 p.m. in New York.
While the heightened volatility has been largely contained in the stock market, that increase may suppress the risk appetite in other assets over the coming months, potentially spurring widespread turbulence, according to Goldman Sachs.
“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 strategists wrote in a note to clients. “The spike in VIX and realized volatility was large enough for investors outside the equity market to take notice.”
The firm identified seven major concerns, including a credit meltdown and growth deceleration, as the biggest threat to financial markets. After studying the relationship between each risk factor and all asset classes, the strategists recommended the cheapest options for each dangerous scenario.
Investors fretting over credit stress should buy options on Utilities Select Sector SPDR Fund and Consumer Staples Select Sector SPDR Fund, they said. For those worried about rising interest rates or inflation, derivative contracts on VanEck Vectors Gold Miners ETF (NYSE:GDX) and iShares 20+ Year Treasury Bond (NASDAQ:TLT) ETF are attractive.
The strategists don’t recommend buying S&P 500 options to hedge against losses in the U.S. equity benchmark, because they see contracts on the Euro Stoxx 50 Index and WisdomTree Japan Hedged Equity Fund as cheaper.
Below is a list of other risks identified by Goldman Sachs and their recommended options strategies:
- Oil: U.S. Oil Fund LP, Energy Select Sector SPDR Fund
- Growth deceleration: Euro Stoxx 50, Energy Select Sector SPDR Fund
- China slowdown: Euro Stoxx 50, Shares MSCI Taiwan ETF, Hang Seng China Enterprises Index
- Europe: Euro Stoxx 50, iShares MSCI EAFE ETF