Goldman Sachs Group Inc., the bank that makes the most trading equities, lost money in the second quarter by betting on a drop in stock-market volatility just as a gauge of equity-price swings surged to a one-year high.
“Primarily in response to our client needs, our equity derivatives business was short volatility entering the second quarter and posted poor results,” Chief Financial Officer David Viniar said on a conference call with reporters today. The firm didn’t break out the size of the loss or the overall results from the equity derivatives group responsible for the business.
The Chicago Board Options Exchange Volatility Index, or the VIX, is the most widely used measure of volatility. The index, which started the second quarter at 17.47, rose as high as 45.79 on May 20 before ending the quarter at 34.54. The index, which measures the cost of using options as insurance against declines in the Standard & Poor’s 500 Index, has averaged 20.38 over its two-decade history.
Goldman Sachs said the division’s revenue slumped 62 percent in the second quarter from a year earlier to $1.21 billion. Still, the unit’s revenue beat equities divisions at JPMorgan Chase & Co., Citigroup Inc. and Bank of America Corp. in the quarter.
‘Volatility Just Spiked’
Clients wanted to hedge against an increase in volatility, Viniar said on the call. “We took the other side because you know we deal with our clients all the time,” he said. “We had that position going into the quarter and volatility just spiked.”
The client demand described by Viniar seems to indicate that clients took the opposite tack of the one recommended by Goldman Sachs’s own economics and strategy team. In a Dec. 2, 2009, note about Goldman Sachs’s “top trades for 2010,” the first recommendation made to clients is that they hold short positions in so-called variance swaps as a way of betting on falling volatility.
“Even in a sluggish recovery and a range-bound equity market, as macro-driven uncertainty declines, volatility can continue to moderate,” the note said.
Risks Not Offset
Some investors and analysts expressed surprise that Goldman Sachs, which prides itself on its risk-management success, didn’t have positions that could hedge any losses.
“I would think they’d try to hedge out and offset those risks,” said Benjamin Wallace, an analyst at Grimes & Co. in Westborough, Massachusetts, which manages $800 million and doesn’t hold Goldman Sachs stock.
Roger Freeman, an analyst at Barclays Capital in New York, asked Viniar on a call with investors today why the firm didn’t have any hedges against the jump in volatility.
“I would say we didn’t hedge it fast enough,” Viniar replied. “Things spiked really dramatically really fast.”
Goldman Sachs, which set a Wall Street profit record for a U.S. securities firm in 2007, reported today that second-quarter profit tumbled 82 percent from a year earlier as revenue from trading equities as well as fixed-income, currencies and commodities dropped 44 percent from a year earlier. The stock rose 2.2 percent to $148.91 as of 6:10 p.m. in New York Stock Exchange composite trading.
Viniar said the firm reduced the size of its market bets during the quarter to the lowest in three years as measured by value-at-risk. VaR, a statistical measure of how much the firm could lose in a single day of trading, dropped to an average of $136 million in the quarter from $161 million in the first quarter and $245 million a year earlier.
“It’s kind of hard to fault them for being wrong every now and then,” said Alan Villalon, a senior research analyst at FAF Advisors, which owns Goldman Sachs shares. “They’ve kept raising the bar themselves, but there’s going to be a hiccup every now and then.”