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Exciting... With Losses: Goldman Q2 Hit Driven By Not Diversifying Its Top 2010 Recommended Trade
In yet another confirmation that the only sure way to make money in the current market is to bet against Goldman's sellside research is the revelation (indeed, reminder) that the primary cause of the firm's now well-known Q2 trading loss, namely the bet that volatility would decline, is precisely what its Top Recommended Trade for 2010 was. During yesterday conference call, David Viniar disclosed that "as a result of meeting franchise client and broader market needs, we had a short equity volatility position going into the quarter. Given the spikes in volatility that occurred during the quarter, equity derivatives posted poor quarterly results." Ironically, on December 2, 2009, as part of its report "Exciting... with Risks" which we previously disclosed, the firm came out with its Top 8 Recommended Trades for 2010, the first of which was the following: "Short S&P 500 Dec10/Dec11 Forward Starting Variance Swap, at 28.20, Target 21. At current levels, forward variance suggests that the coming years will be as volatile as 2009. But this year was the eighth most volatile year on record, and our recent work on the 2004-template—and our models linking macro outcomes to volatility—suggests that even in a sluggish recovery, volatility can continue to decline. While near dated volatilities remain only moderately elevated, the upward-sloping term structure has kept forward variance higher—and well above where it ‘belongs’." In other words, Goldman recommended selling vol, yet it only did so as a flow counterbet after a customer did precisely the opposite of what Goldman was pitching.
As Risk Magazine observes, the sell vol trade was prevalent and many banks got whacked as a result:
Bank of America Merrill Lynch – another of the banks said to have lost
money on short volatility positions – reported a $678 million drop in
equities profits in its second-quarter report, blaming "unfavourable
market conditions and increased volatility, which negatively impacted
the equity derivatives business".
Any dealers that held short volatility positions or short variance positions going into May will have endured a rough ride. The dislocations in May followed intense anxiety about Greek sovereign debt, contagion to other eurozone sovereigns and banks, and fears over the future of the euro. Volatility leapt, with the Chicago Board Options Exchange's Vix index, which measures market volatility as implied by 30-day Standard & Poor's option prices, rising from 24.91 points on May 5 to 40.95 points two days later – a jump of 64%. It continued to creep upwards, hitting 48.2 points intra-day on May 20 – a 13-month high.
There was also a peak in skew – the difference in implied volatility between out-of-the-money put options and out-of-the-money calls. Three-month 90–110% implied volatility skew on the Dow Jones Eurostoxx 50 index touched 15% on May 20, compared with a high of 12.8% seen after the collapse of Lehman Brothers in 2008, says Deutsche Bank.
One exotics trader says the whole Street would have struggled in May to a greater or lesser degree. "This move caught people by surprise. Look at the Vix – it moved from 25 points to 40 in two days. It took two weeks to spike that much after Lehman – it's a huge move. I can tell you every dealer on the Street was probably short skew and short volatility," he says.
Here is the relevant page from the Goldman research report:
Of course, Goldman couldn't care less about its sellside team as the Abacus fiasco disclosed: the firm would generally take the opposite side of trades its salesmen pitched to clients. The only reason the firm got hit hard in Q2 is because not only was its research 100% wrong, but that Goldman was unable to offload prop risk from taking the other side of a massive long vol bet as all other dealers were on the same side of the trade and all the Korean and European idiot banks abused during the CDO period of the bank's history were made bankrupt by following Goldman's advice. Also, of the Top 8 recommendations above, we are confident the total P&L loss would be sufficient to destroy all but the largest hedge funds.
Which is once again why we repeat our long-held belief that whatever Goldman's "clients" do, they are in a far better position strategically if they merely take the other side of Goldman's trade recommendations.
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Unfavorable market conditions..... that's a new one for a bank.
Is it too much to ask that the SEC stop their porn addiction for just a few days and connect some dots? I'm so sick of this cr@p just being allowed to pass. "Oh, we disclosed it in a foot note that you need a microscope to read.." Guess transparency has been dead a long time, why should I even get excited? Scum bags.
Umm, last I checked, $500million in hush money is effective. Plus, makes premium porn content affordable.
Short volatility? LMAO! Maybe it wasn't double reverse psychology afterall....
supports the notion that the NYFed intervenes on behalf of GFS et al into expirations
scumbags
And who comprise the Board of Directors that run the Fed?
The situation was a little bit more complex, and more profitable.
Goldman was shorting vol (via variance swaps) at 80,70,60... in early 2009. I was still in hte business and saw them do it. They made a killing. However they didnt like the position so much with the VIX under 25. So they tried to get clients to sell it to them.
From what I hear and saw at the time, the position was huge. Millions of dollars of vega. Evidently they couldnt clear the portfolio before the VIX spike.
Essentially lack of client flow bit their traders in the ass. Not many people trade variance swaps any more, most who did got fired in'08.
And no, there is essentially no difference at GS between an official prop desk / internal hedge fund, and the client facing guys who are allegedly "flow". It was the flow desk and the prop guys combined who put this trade on.
in fact, variance swaps are more liquid than ever. there is plenty of client flow, but it's all one-way.
Goldman Sachs was short volatility because its clients wanted to be long volatility. That is what Goldman Sachs does, it facilitates risk trades for its clients. If clients want to take one side of "A", then Goldman takes the other side of "A".
What Goldman normally would do is they would find ways to hedge the resulting exposure from its clients' trades, in this case the short vol position, and make a return on the net of all the transactions. Obviously that did not work out well for GS this time, but it did work out well for GS' clients, since they got the exposure they wanted and GS gave it to them.
You see, this is where Tyler's Goldman narrative fails. Goldman Sachs works on behalf of its clients, Goldman's clients appreciate it, and they reward Goldman with the leading franchise in just about every product category on the Street. Goldman usually makes money facilitating trades; this time it did not.
You've obviously never traded with Goldman. Speaking as someone who has, the general consensus on the street is that if Goldman gets you done then you got picked off. Their market making desks are there to facilitate their prop trading activities. They can make spreads as wide as they want to avoid adding additional risks to their books. Thus, if they found themselves short vol I assure you they wanted to be. Dude know what the hell your talking about before you go off on your pro-Goldman rants.
..
I know more about the internal workings of Goldman Sachs Equities and FICC than you could ever possibly know. Q.E.D.
And based on your comments you seem to know almost nothing about finance. Let me guess you're some low level systems or ops analyst. Congrats. As a former customer I assure you that you are maligned by all of your clients who you seem to think adore you.
well, rick the dick, since i have amassed a capital account about which you could only dream, and since I did it despite "know(ing) almost nothing about finance", then I must be one lucky fellow.
;>)
Oh of course. How could I have doubted your investing expertise after that all the gems you've provided, like comparing small business to owning shares of a publicly traded company. Lol. You absolute moron.
I also enjoyed you bashing an analyst for downgrading a stock to sell because it was trading at his current price target. I guess you amassed that fortune buying and holding names with no upside.
I think Goldman Sachs made some bad trades on purpose. They were getting too much heat. By purposely losing, they can now argue that it is not a rigged game and that they don't win 100% of the time. Goldman still winning guys.
DOW chart update :
http://stockmarket618.wordpress.com
I’m guessing Goldman put their trading position on before they launched a recommendation to their clients like it was a gift of revelation from the God of Economics. Among other things, the process of establishing their position in advance would have helped move the market in support of their recommendation. It would have been sweet for Goldman if all their clients had followed their advice, allowing Goldman to take the other side of their action for an immediate profit. It’s just another version of front running if you ask me, albeit with a somewhat less certain outcome. It supports something I’ve always said about Goldman Sachs, “Their analysts and advisors really only have one client in the end; it’s Goldman Sachs.” Be wary when you act on someone’s financial advice only to find out that your counterparty in the deal is them.
I think this example also helps prove how the only way Wall Street firms can make guaranteed trading profits 100 days in and row is when they stay focused on the games that are completely rigged in their favor. I wonder which Goldman VP got fired for straying too far from his carnival side show booth this time.