Will volatility make a comeback? Goldman Sachs expects increased risks and recommends buying VIX call options

This Wednesday, the "fear index" VIX, which measures the volatility of the US stock market, rose by 3.5% to 18.23 points. As of that day, it had risen for three consecutive days, still showing a cumulative decline since August, far below the four-year high of 38.57 set on "Black Monday" on August 5th. 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 rising volatility.

Goldman Sachs' options research team listed 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 frameworks, seasonal volatility increases, and upcoming macro/micro catalysts. It is expected that the level of VIX will begin to have the potential to rise. Based on the current macroeconomic environment, Goldman Sachs' volatility economic model estimates that the VIX level should be 24.5. If each explanatory variable encounters a one standard deviation economic shock, the VIX level will reach 33. In comparison, VIX was only about 18.2 this Wednesday.

Among the explanatory variables of the volatility model mentioned above, Goldman Sachs found four variables that are particularly important for explaining volatility: 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 found that volatility tends to rise seasonally. Over the past 30 years, VIX has averaged a 6% increase from September to October each year. Based on research on regional volatility seasonality, Goldman Sachs found that the volatility of major stock indices tends to rise consistently from August to October. Considering seasonal factors and upcoming macro/micro catalysts, Goldman Sachs believes there is upward risk in the current VIX level.

Goldman Sachs believes that this seasonality stems from investors and listed companies paying more attention to managing performance at the end of each natural year.

The Goldman Sachs report points out that their long-term research shows that election years have a minimal seasonal impact on the actual volatility of the S&P 500 index. However, their analysis of VIX shows that from 1990 to 2023, in election years, the seasonal impact on stock index volatility in October is greater, with an average volatility of 25 for that month, exceeding all other months in election years and all months in non-election years. Note: Over the past 34 years, there have only been 8 election years.

Goldman Sachs believes that this further supports their view that holding VIX rather than the actual volatility of the S&P 500 index, although the seasonal impact of election years may be driven by higher volatility in 2008 and 2020 The third key reason is the upcoming macro/micro catalysts. A Goldman Sachs report listed some major catalysts expected to come, such as the U.S. election, the November and December meetings of the Federal Open Market Committee (FOMC) of the Federal Reserve, and the earnings season of U.S. listed companies in October, all of which are expected to drive up volatility expectations.

The report stated 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 mentioned that Goldman Sachs recommends VIX call options instead of SPX put options because their GS-EQMOVE model indicates that upward asymmetric pricing is very attractive