Equity derivatives desks at JPMorgan Chase and Goldman Sachs have thrived as a furious correction in U.S. stocks took hold in the past six days, according to people with knowledge of the situation. The desks sell options and futures to trading clients as protection against losses or to allow them to speculate on price movements.
Banks positioned themselves to be long volatility – in other words, to benefit if volatility spiked – by snapping up options contracts ahead of the market rout, according to the people. Options allow investors to protect against price movements in exchange for paying regular premiums. When crashing markets sent the Cboe Volatility Index soaring, those positions suddenly increased in value.
The VIX, known as the "fear gauge" of Wall Street, rose above 49 on Friday, an alarming jump not seen in two years. As recently as November, the VIX had been around 12.
At the same time, clients who were previously complacent about market risks clamored for options to protect against further moves, causing a jump in activity for banks.
"Equity indexes were rallying last year," said one of the people, who declined to be identified discussing nonpublic information. "With some macro indicators giving people pause, and you add coronavirus to the mix, there was the feeling that volatility would spike. It ended up being the perfect scenario for them."
The desks are projecting sharp increases in stock trading results for the quarter thanks to the activity, said the people. The derivatives business is one of banks' three major stock trading segments, which also includes prime brokerage and cash equities desks.
On Tuesday, as the stock rout was gaining steam, JPMorgan co-president Daniel Pinto told bank investors that trading was "doing very well" in the quarter and was headed towards a "mid-teens" percentage increase. A year ago, that business generated $5.47 billion in bond and stock trading revenue.
"There's been a major macro event," said another person, referring to the coronavirus. "Investors have had to change views on outlook for growth, caused a repricing in risk assets."
One jubilant trader said that if these conditions last a few more weeks, he will be on track to hit his performance targets for 2020 months early.
JPMorgan and Goldman are the two biggest Wall Street shops when it comes to equity derivatives, according to industry research firm Coalition. The banks each made roughly $1.5 billion in revenue from that last year.
The action echoed the so-called "volpocalypse" of February 2018, almost exactly two years ago, when calm in markets was shattered with an historic surge in volatility, wiping out several retail funds that bet against volatility in the process.
That ended up being JPMorgan's best-ever quarter for stock trading revenue, at $2.02 billion. At Goldman Sachs, the action resulted in the bank making a staggering $200 million in profit on a single day, CNBC reported that year.
Investors may have to get used to big, sudden moves in the stock market. A series of changes to market structure in the past decade help to exacerbate such declines, JPMorgan's Pinto has said. And the rise of options trading helps to suppress market swings for long periods of time, ultimately magnifying volatility when it does arrive.