The investment bank reaped a $200 million profit on Feb. 5, the day volatility exploded back to life in equity markets as the Dow registered its largest one-day point drop in history. The bank's score can be attributed to long-vol positions that had recently been put on by the flow derivatives group, a group within Goldman's equity desk responsible for trading VIX derivatives. The $200 million in profits is roughly equivalent to what Goldman's derivatives desk takes home for the entire year. For all of 2017, the trading business for the entire bank exceeded $100 million in revenue on just four days.
During the selloff, demand for the bank's VIX futs inventory from its institutional clients suddenly soared, making its positions incredibly profitable, and they were quickly sold at an unprecedented daily profit. The trade was a major boon for Managing Director David Casner, head of the flow derivatives group, who joined the bank in 2002.
According to CNBC, Casner's trade was by far the largest contributor to the 38% jump in equity trading revenue to $2.3 billion, which exceeded expectations for Goldman, and also exceeded results for Morgan Stanley and JP Morgan, Goldman's two biggest equity-trading rivals.
Here are the standouts from Goldman's Q1 earnings report, which we profiled previously:
- Equities sales & trading revenue $2.31 billion, estimate $1.85 billion, up 38% from $1.67 billion
- Trading revenue $4.39 billion, estimate $3.89 billion, and up 31% from $3.36 billion
- Investing and Lending (Prop) revenue $2.087 billion, up 43% from $1.464 billion
Here's what Goldman initially said about its equities trading revenue:
Net revenues in Equities were $2.31 billion, 38% higher than the first quarter of 2017, primarily due to significantly higher net revenues in equities client execution, reflecting significantly higher results in both derivatives and cash products. In addition, commissions and fees were higher, reflecting higher market volumes, and net revenues in securities services were higher, reflecting higher average customer balances. During the quarter, Equities operated in an environment characterized by periods of high volatility and an increase in client activity compared with the fourth quarter of 2017
And here's how Goldman's outlier quarter, its best Q1 2015, looks in context:
Yet what makes this particular trade especially surprising, is that just three weeks before the February 5 volocaust, we noted that Goldman was actively urging its clients to protect against precisely the kind of VIX exploding eventuality and buy VIX, when in a note from its derivatives strategist Rocky Fishman, Goldman observed that "VIX ETPs are now net short vega - should we worry?"
As we further pointed out in January, Goldman actually predicted step-by-step just how the sequence of events on February 5 would play out:
"VIX ETP rebalancing would be most impactful should there be a quick SPX selloff near the end of a trading day, pushing issuers to rebalance positions quickly to avoid unhedged overnight risk (ETN issuers) or excessive tracking error (ETF issuers). With the rebalancing need primarily driven by inverse products instead of levered long products, a multi-day volatility spike (e.g. VIX futures rise 1-3 points for several days in a row) would be less impactful than it would be with more levered long product open interest, since absent inflows the inverse products would shrink quickly on an initial vol spike (and their vega-buying is limited to the total position they are currently short)."
Just a few weeks later, on February 5, this is precisely what happened however instead of having urged
the muppets its clients to take the other side of the trade ahead of the crash, Goldman was actually aligned with them for once. If anything, the outlier profitability of Feb 5 for Goldman's flow desk means that the bank's clients did not listen to it as they - for once - should have!
Then again, Goldman's bets could've just as easily gone awry, just like an ill-fated bet on regional natural gas prices that hampered commodity trading revenues last year, which was Goldman's worst year for trading revenues since 2004.
The good news for Goldman, and its shareholders, is that if the investment bank's strategists are correct - Goldman will soon have many more, and far more lucrative opportunities to profit from a surge in volatility.