Key Takeaways:
Goldman Sachs is warning that risk assets have rallied too aggressively, recommending investors hedge against a potential downturn after the S&P 500 touched a record 7022 points on April 16.
"The market has gotten overextended," Tom Shea, a trader at Goldman Sachs, wrote in a report. He advised investors to build hedge positions "while there's still time" against two potential risk scenarios.
The report details six specific trades across stocks, credit, interest rates, foreign exchange, and commodities. Each trade is structured to limit the maximum loss to the premium paid, with one equity option strategy offering a potential return of more than 13 times the initial cost.
The two scenarios Goldman Sachs identified are a re-escalation of geopolitical tensions and a period of persistent de-risking marked by slowing growth and high inflation. The proposed hedges are designed to offer protection and upside in these specific situations.
For equities, the bank recommends buying a put spread on the SPDR S&P 500 ETF Trust (SPY). The report notes that after falling about 9% from a January high of 6978 to a March low of 6368, the index rebounded to an all-time high, while implied volatility has fallen, making options cheaper.
The specific trade is buying the May 8 expiry 680/630 put spread for a $3.80 premium, with the SPY at a reference price of $699.94. This expiration date covers earnings reports from about 80% of S&P 500 companies, the Federal Reserve's meeting on April 29, and the May 8 non-farm payrolls data release.
In credit markets, Goldman Sachs suggests buying protection on the CDX Investment Grade (IG) index and shorting a basket of high-yield (HY) bonds. The report notes that the CDX IG index offers liquid exposure that becomes highly correlated to stocks during market stress. For high-yield, the bank identifies it as the segment with the weakest technical backdrop due to persistent fund outflows.
For interest rates, the firm sees value in receiver spreads, which would profit from a fall in rates. Goldman's view is that the market is underpricing the possibility of rate cuts over the next three years and that any significant move lower would be led by the front end of the curve.
In foreign exchange, the report identifies the British pound as particularly vulnerable to an energy shock. The recommended trade is a binary put option on the GBP/USD pair, targeting a move down to 1.235 by December 18.
The final recommendation is a call spread on the BCOM Grains Index, composed of corn, soy, and wheat futures. Goldman argues that grain prices have not fully priced in the risk of disruption to fertilizer supplies, as about 50% of global urea passes through the Strait of Hormuz. A sustained period of high fertilizer prices could impact future planting seasons, tightening supply.
The report's release provides a notable counterpoint to the prevailing bullish market sentiment. Investors will be watching the upcoming Federal Reserve meeting and non-farm payrolls data as key tests for the market's direction and the thesis outlined by Goldman Sachs.
This article is for informational purposes only and does not constitute investment advice.
