On Wednesday this week, the "fear index" that measures the volatility of the US stock market - $CBOE Volatility S&P 500 Index (.VIX.US)$ closed up by 3.5% at 18.23 points, marking a three-day consecutive increase as of that day and still accumulating a significant decline since August. It is far below the four-year high of 38.57 set on August 5, 'Black Monday'. However, this downward trend in volatility is not expected to last. The team believes that risks will increase before the election and recommends buying VIX call options.

Overall, Goldman Sachs believes that low implied volatility (IV), the upcoming October earnings season, and the US presidential election all provide attractive opportunities for investors to hedge against potential volatility increase.

Goldman Sachs' options research team lists three key reasons for holding VIX in a recent report. The first key reason is Goldman Sachs' volatility economic model, which models stock volatility based on economic framework, seasonal volatility increase, and upcoming macro/micro catalysts, and predicts that VIX levels will start to have upward potential. Based on the current macroeconomic environment, Goldman Sachs' volatility economic model estimates that the VIX level should be 24.5, and if each explanatory variable experiences a one-standard-deviation economic shock, the VIX level will reach 33. In contrast, VIX was only about 18.2 on Wednesday of this week.

Among the explanatory variables of the volatility model mentioned above, Goldman Sachs found four that are particularly important for explaining volatility: the unemployment rate (year-on-year), non-durable goods PCE growth (quarter-on-quarter), ISM New Orders Index, and the absolute difference between core CPI (year-on-year) and core PPI (year-on-year).

The second key reason is that Goldman Sachs' historical research on volatility has found that volatility tends to rise seasonally. Over the past 30 years, VIX has averaged a 6% increase from September to October. Based on research on seasonal volatility in various regions, Goldman Sachs found that major stock indices show a consistent upward trend in volatility from August to October. Taking into account seasonal factors and upcoming macro/micro catalysts, Goldman Sachs believes that there is upside risk to the current VIX level.

Goldman Sachs believes that this seasonality is due to investors and listed companies paying more attention to managing performance at the end of each calendar year.

According to a Goldman Sachs report, Goldman Sachs' long-term research shows that election years have a relatively small seasonal impact on the actual volatility of the S&P 500 index. However, Goldman Sachs' analysis of VIX shows that from 1990 to 2023, in different months of election years, October has a greater seasonal impact on stock index volatility, with an average volatility of 25 in that month. This not only exceeds all other months in election years, but also exceeds all months in non-election years. Note: In the shorter time span of the past 34 years, there have only been 8 election years.

Goldman Sachs believes this further supports Goldman Sachs' view that holding VIX rather than S&P 500 actual volatility, although the seasonal effect of election years may be driven by higher volatility in 2008 and 2020.

The third key reason is the upcoming macro/micro catalysts. The Goldman Sachs report lists several major catalysts expected to occur soon, such as the U.S. election, November and December meetings of the Federal Open Market Committee (FOMC) of the Federal Reserve, and the earnings season for U.S. listed companies in October, all of which are expected to drive up volatility expectations.

The report states that although election years may not boost actual volatility, buyers of VIX call options will benefit from the potential surge in implied volatility.

The report also mentions that Goldman Sachs recommends VIX call options instead of SPX put options because Goldman Sachs' GS-EQMOVE model indicates that attractive pricing exists for asymmetric upside.

Editor/Emily