In an environment of extreme market volatility, Goldman Sachs Group adjusted its investment strategy for the artificial intelligence (AI) sector ahead of the technology earnings season and the Federal Reserve decision: it recommends that investors "rent" the upside of an AI rebound through option structures rather than directly holding spot positions, while simultaneously allocating lookback put options as hedging "insurance."
Goldman Sachs' derivatives trading desk said in its latest report that although earnings support and light positioning at a five-year low could push stocks higher before the end of the year, concerns about the AI outlook, the Middle East situation, and the U.S. midterm elections will keep near-term market volatility elevated. To this end, Goldman Sachs recommends capturing upside gains through option structures with limited losses, indicating that Wall Street institutions want to participate in a potential short squeeze without fully bearing the risk.
This strategic shift is directly reflected in the divergence in options market pricing. At present, options market pricing for large technology stocks (Mag 7) shows that the panic period appears to be over, with implied volatility at an extremely low level over the past four years; for emerging cloud service providers (Neoclouds), however, market pricing shows that the crisis has only just begun.
This complex operation of "wanting both upside gains and downside protection" highlights the deep divergence in current market capital over the outlook for the AI ecosystem. Investors are trying to find a fragile balance between systemic risk and a potential "Santa rally."
Strategy shift under extreme volatility: "renting" upside
The report said that extreme market volatility is the core reason prompting Goldman Sachs to change its strategy. Data shows that Goldman Sachs' momentum factor basket has had 30 single-day moves of more than 5% this year, a frequency that even exceeds the dot-com bubble in 2000, the 2008 financial crisis, and the COVID-19 period.
Against this backdrop, Goldman Sachs' derivatives trading desk explicitly recommends that clients "rent" the upside of the AI sector. Goldman Sachs' preferred hedging tool is the S&P 500 Index (SPX) March 2027 90% lookback put option. The strike price of this option rises with the market's daily movements, and the cost is only 1.82%. Goldman Sachs noted that this allows clients to obtain downside protection without perfectly timing the market, while retaining exposure to the year-end rally.
Severe divergence in market pricing: large technology stock volatility plunges
Although hedge funds and long-only institutions have recently sold nearly $20 billion of technology, media, and telecom (TMT) stocks, approaching the scale of July selling, options pricing for large technology stocks is unusually cheap. According to Goldman Sachs data, the implied volatility of large technology stocks relative to the overall technology sector is at the 15th percentile over the past four years.
Taking a giant about to report earnings as an example, Goldman Sachs is bullish on Amazon's December 280/310 call spread structure, noting that the stock has fallen about 10% from its high for the year while holding support, and that recent deleveraging resembles the environment before its sharp July rally.
For Microsoft, the options market implies post-earnings volatility of only 4.7%, far below 15.5% last quarter. In addition, the implied volatility spread between the Nasdaq 100 Index and the S&P 500 Index has fallen sharply after a recent surge, indicating that a large amount of volatility premium has been sold.
Addressing high correlation: short index volatility, long single-stock volatility
As AI concept stocks show a high degree of consistency when falling, buying in index volatility is stronger than in single stocks. Adrien Simonet of Goldman Sachs' structured products team noted that the 12-month implied correlation of the Nasdaq 100 Index has climbed from the mid-20% range in summer to 32.6%. Meanwhile, the ratio of single-stock volatility to index volatility has slipped from above 2.0 to 1.8.
To this end, Goldman Sachs' solution is a dispersion trade: short index volatility while going long single-stock volatility. This strategy uses a variance swap portfolio comprising 19 Nasdaq constituents including Apple and Nvidia to use the index volatility risk premium to fund long single-stock volatility. Historical data shows that during past drawdowns, the realized volatility of long stock portfolios was often higher than index volatility.
Beware of emerging cloud service provider risks and "knock-out" option traps
In sharp contrast to the low volatility of large technology stocks, emerging cloud service providers are facing a severe test. Goldman Sachs' emerging cloud service provider basket fell more than 28% this month. For investors hoping to bet on a rebound, Goldman Sachs prefers using CoreWeave's convertible bonds rather than directly holding its plunging stock.
The convertible bond has fallen 1 to 2 points this month on a delta-neutral basis, while the underlying stock has fallen 30%. Compared with ordinary bonds, the convertible bond offers about 300 basis points of extra yield; its current implied volatility is 46 to 57, while the implied volatility of listed options exceeds 80, and it can be hedged through CDS and ordinary bonds.
According to observations by JPMorgan, AI-related credit default swap (CDS) spreads have widened sharply as lenders buy CDS to hedge data center loan risk. JPMorgan warned that emerging cloud service providers face bankruptcy risk, and large technology companies may acquire these bankrupt assets at extremely low prices.
In terms of derivative structures, Goldman Sachs offers clients seeking modest upside gains 3-month 105%/130% continuous knock-out call options. The structure is extremely cheap, costing only a fraction of an ordinary call option. However, its additional conditions are extremely harsh:
Investors can obtain 1:1 returns above 105%, but if the stock price touches 130% at any point during the trading day, the option becomes void directly and the return falls to zero.
In a market where momentum stocks frequently see single-day moves of 5%, this "cheap" structure actually carries enormous hidden risk.
Which inning is the market in? A rebound still requires multiple conditions to align
Regarding the current adjustment cycle in the AI ecosystem, Goldman Sachs derivatives expert Brian Garrett believes the market may be in the "eighth inning of a large-scale deleveraging phase," rather than the "second inning of a repricing of the entire AI ecosystem."
However, to confirm that the market has truly bottomed and is set for a rebound, three harsh conditions must be met: bond market volatility must decline, uncertainty over the U.S. midterm elections must be removed, and AI capital expenditure must pay off in corporate earnings.
In addition, Goldman Sachs has also aimed high-beta trading opportunities at the South Korean market, recommending EWY (South Korea ETF) call spreads to capture chase buying triggered by capital flowing back in.
Goldman Sachs prime brokerage data shows that the South Korean market suffered large-scale net selling this month, with both net and gross positions falling sharply. Once the AI trade reignites, it could trigger chase buying. Goldman Sachs recommends the EWY December 180/210 call spread, with a reference price of $157.65 and a cost of $3.70.
Overall, Wall Street institutions are currently "renting" upside through capped, knock-out, and spread structures, paired with lookback put options, essentially pricing a short-term technical rebound rather than betting on the start of a new bull market. Systemic risks in the market still exist, and record long positioning in the Nasdaq remains the main hidden danger hanging over the market.
Comments