- A closely watched stock-market indicator looks broken to Goldman Sachs, which cites aberrant trading in recent weeks.
- The firm provides a trading strategy that could generate serious profits if the gauge snaps back to reality.
Something is not right with the VIX.
So says Goldman Sachs, which thinks the gauge — officially known as the Cboe Volatility Index and viewed as a proxy for market fear — is too low.
At the core of the firm's stance is the disparity between how much the benchmark S&P 500 has moved in past weeks, relative to the comparatively small move in the VIX.
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"There is a mismatch between how little SPX options cost (June straddle with over five weeks to maturity costs 3%) and how much the SPX has been moving (3.5% rally over the past five trading days)," Rocky Fishman, an equity derivatives strategist at Goldman, wrote in a client note.
While the VIX traded in the mid-13s on Friday, Fishman says recent economic data is more consistent with a level exceeding 15. He also says that the VIX's historical relationship with realized volatility suggests the gauge should be closer to 18. Those are big pricing discrepancies.
But instead of lamenting this wonky VIX trading, Fishman suggests investors take advantage of the opportunities it creates. After all, he sees an S&P 500 selloff pushing the fear gauge back into the 20s, and says traders should be positioned to capture that increase.
He recommends investors buy VIX call spreads expiring in June — strategies designed to profit from a modest increase. (Note that such a bullish call spread involves the purchase of call options at a specific strike price, and the simultaneous selling of the same number of call contracts with the same expiration, but at a higher strike.)
If traders put on this trade, they could see returns at a six- to 12-times multiple to their original investment. Not a bad risk-reward profile at all.
Overall, Fishman's suggestions highlight a tried and true maxim of the market: Mispricings are often a blessing, not a curse, and investors would be well-served to survey them for cost-efficient trades.
