Reuters / Vincent West
- Goldman Sachs forecasts volatility will increase into the end of 2018, a situation that could catch some stock traders off-guard if they're unprepared.
- The firm has come up with a strategy designed to offer single-stock upside for equity bulls, while also giving them better downside protection.
When the stock market is headed for a turbulent patch, it can be stressful for traders to sit idly by and let the volatility whipsaw their investments.
That's why Goldman Sachs is suggesting a strategy that allows them to take an offensive approach. The firm recommends equity investors replace their single-stock holdings with bullish call options - a bold and unorthodox approach.
The logic here is pretty straightforward: The options provide ample exposure to the upside while limiting downside potential. As long as price swings are mostly in a positive direction, it can be profitable.
"We believe owning calls is more attractive than holding stocks for investors that expect volatility," Katherine Fogertey and the rest of the firm's derivatives team wrote in a client note. "By reducing exposures in a way that still allows for upside exposure from options, investors still maintain upside potential from both their stock and the option, but their downside risks are more limited in the case of a draw down."
But wait a minute, hasn't volatility declined since the market's rocky patch in early February? Yes, but Goldman forecasts an uptick in price swings, making this the perfect time to apply its strategy.
The firm forecasts that single-stock realized volatility will rise into the second half of 2018. And as the chart below shows, there's still plenty of room for the measure to increase if it's to revert to historical averages.
With all of this in mind, any strategy is futile if an investor fails to pick the right stocks.
The onus is ultimately on active managers to prove their bonafides and show they know how to seize opportunity in the market. Goldman's strategy recommendation is merely a vessel for them to more aggressively express those views.
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