The Street is abuzz with speculation Goldman Sachs has taken a hit on a short equity volatility position since equities started tumbling last month. Market reports place the losses at around USD150 million.
Rebecca Nelson, spokeswoman for Goldman in London, said, "There's no basis whatsoever for these rumors." But equity market watchers said the reports have been backed up by Goldman's recent trading activity. The firm has appeared to be buying up call options on Standard & Poor's 500 variance in size, with deep out-of-the-money strikes at 30% and August and September expiries.
In these exotic options, usually bought for directional volatility plays, the payout is the difference between the strike and realized variance so strikes tend to be lower than implied volatility levels--which were around 15% as DW went to press Friday. The buzz is that Goldman was short emerging-market volatility but as EM option liquidity has dried up, traders have been buying options on S&P variance as a proxy hedge.
"The levels they were paying were panic levels," said one admittedly biased trader at a rival firm, noting the out-of-the-money strikes on the options meant they were unlikely to be trades for clients. S&P implied volatility as measured by the VIX index has been volatile itself, jumping up to 23.8% June 13 from 20.9% the day before, then coming back down to 15-16%. One strategist noted holding options on variance would mean the trading book would have a mark-to-market gain if volatility continues to be move around. It could also be used as crash protection, but plain-vanilla equity index puts are more liquid and more commonly used for this.
