Goldman's Top Vol Trades For 2011
Goldman's Krag Gregory has proposed several interesting vol ideas all of which, however, are predicated by Goldman's attempt to merely leverage (clients) into the company's bullish outlook on the economy and markets. To wit: "Our US Portfolio Strategy team’s SPX target of 1500 coupled with high 1y skew and low rates biases us to strategies that sell expensive puts to fund upside." The eight trades specifically are: Trade #1: Sell S&P 500 Dec-11 variance at 22.8; Trade #2: Sell RUT Dec-11 variance at 30; Trade #3: Sell S&P 500 Apr-11/Dec-11 forward variance at 24.2; Trade #4: Risk reversals. Buy a Dec-11 S&P 500 104.6% call; Sell a 90% put to fund; Trade #5: Knock-in risk reversals. Buy a Dec-11 S&P 500 102.7% call. Sell a 95% put with a 82% (1060) knock-in to fund; Trade #6: 1x2 Call spread overlay. Buy Mar-11 SPX 100%/104.4% 1x2 call spreads for 1.4%; Trade #7: Buy Dec-11 SPX 100%/116% 1x2 call spread; sell a 8.5% OTM put to fund as a standalone options strategy; Trade #8: Calendar spread as a hedge. Buy Mar-11 SPX ATM put, sell Dec-11 82% put to fund.
Specifically, GS divides its trade recommendations into two key categories: variance trades, which are a repeat of the firm's top trade for 2010, that ended up costing Goldman serious P&L in Q2 when the market plunged, and directional trades:
Top US variance trades for 2011
Our forecast for lower realized vol in 2011 coupled with a steep term structure biases us toward short 1y variance trades which benefit from a roll down the curve. Elevated 1y skew means that variance is trading rich relative to ATM implieds. We like selling Dec-11 variance on SPX and RUT. Steep term structure environments also imply high forward volatility and we like selling forward variance on S&P 500 and settling on realized.
Top S&P 500 directional trades
Our US Portfolio Strategy team’s SPX target of 1500 coupled with high 1y skew and low rates biases us to strategies that sell expensive puts to fund upside. As a result, risk reversals are our preferred strategy for gaining upside exposure. Managers looking for levered short-term upside exposure may consider 1x2 call spread overlays. As our preferred hedge, we like selling SPX Dec-11 18% OTM puts to fund Mar-11 ATM puts as current term structure is near decade highs.
The overarching theme behind all the trades is the firm's expectation for i) a declined in realized vol to 15 by the end of 2011, and ii) the S&P hitting the firm's revised forecast of 1,500. Since both of these appear increasingly improbably now that the inflation genie is finally out of the bottle, and since Goldman's prop traders are selling these trades to clients, it is as usual best to be positioned on the "other" side.
The combination of stronger US growth, moderate inflation, and accommodative monetary policy should be supportive of risky assets and lower realized volatility in 2011. Our forecast for S&P 500 realized volatility is 15 for 2011 and our US Portfolio Strategy team has a year-end S&P 500 target of 1500. In the options market, S&P 500 one-year skew remains on par with 2008-2009 crisis levels, the term structure is near its steepest level on record, and 1y variance levels are predicting realized vol over 2011 will be 6 points higher than realized volatility in 2010. We highlight ways to use the existing anomalies in the options market to position for directional upside and a decline in volatility in 2011.
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