As the curtain fell on 2024’s last trading day this past Tuesday, a notable trend emerged in the stock market, particularly within the S&P 500 indexThe final session saw the index close following a significant four-day decline, marking the longest consecutive year-end drop since 1966. This scenario played out despite the index showcasing a strong performance over the yearBrian Garrett, a prominent trader at Goldman Sachs, reported in his last memo of the year that market behaviors in the final two weeks deviated remarkably from his forecasts.

The landscape of the market shifted dramatically beginning December 16, when traders anticipated a modest volatility for the S&P 500 index—estimated at 1.25%. This measure was derived from a trading strategy known as a Straddle, where an investor simultaneously purchases or sells call and put options that share identical underlying assets, expiration dates, and strike prices, thus reflecting market expectations for future volatility.

However, the reality tipped the scales; post-December 16, the average daily trading range of the S&P 500 experienced a higher volatility of approximately 1.35%. What does this imply? It signifies that actual market fluctuations surpassed the expectations that were embedded in the options pricing.

Garrett raised concerns about the recent surge in short selling, which he attributed partly to prevailing technical market dynamics

Furthermore, diminishing market liquidity seemed to amplify the consciousness surrounding risk management, as positions betting against the market (short positions) began to increase while net positions dwindledDrawing comparisons to the previous year's initial calm, Garrett hinted that the upcoming year might usher in greater volatility and unpredictable market conditions.

Given the context, Goldman Sachs suggested several strategies for navigating the changing landscape: They advocated a shift in focus towards equal-weighted indices as opposed to market-cap-weighted indicesAdditionally, they encouraged investors to lean more toward mid-cap stocks rather than large-cap stocksAllocating a portion of investments into gold, along with utilizing six-month options for market downside protection, emerged as another cornerstone of their advice.

Another critical point of focus is the volatility index, VVIX, a tool that measures the volatility of VIX options, with a value above 110 indicating heightened caution

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Beyond that, Garrett also urged investors to look towards potential merger targets, especially in regions outside the United States, particularly as the dollar strengthens.

A fascinating overview from the Goldman report highlighted a newfound pattern in the options market for 2024, termed ‘partitioning.’ This pattern signifies rapid increases in market volatility in response to risk events, followed by equally rapid declines—a behavior unseen in the past three yearsThis volatility may be attributed to structural components related to index Gamma supplyGarrett suggested that should an extended period of softness arise in the market, short-term option prices may fall swiftly, thereby providing investment opportunities for those poised to buy at lower levels.

Utilizing the final days of December as a practical illustration, Garrett evidenced the importance of Gamma to market activities

He asserted that the correlation between volatility and Gamma became a noteworthy concern roughly two years ago, evolving into a crucial daily analytical parameter since then.

Reflecting on the breadth of the market in December, a conspicuous decrease surfaced, with the number of declining stocks outpacing advancing ones on about 70% of trading days throughout the monthIn this context, the resilience of the S&P 500 was strikingAn alternative analysis measuring the returns of equal-weighted SPX against market-cap-weighted SPX illustrated a staggering 6% disparity in performance for 2024.

Despite the hints of a retail trading frenzy earlier in the year, there has been a marked cooling in the aggressive buying of mega-cap tech stocksThe fervor has waned significantly, with retail interest reportedly dropping by around 75% since its peakWhen these large-cap tech stocks exhibit gradual rather than sharp increases, the appetite from retail traders appears to diminish.

Furthermore, Garrett delved into the costs associated with one-year at-the-money (ATM) calls and put options

Currently, the cost of a one-year ATM call option is considerably highFactoring in interest rates and dividends, purchasing a one-year SPX option entailing a strike of 5900 points, with hopes it would reach Goldman’s predicted S&P 500 level of 6500 points by the end of 2025, yields only a modest return of approximately 20% on the premium at expiration.

Goldman also introduced their custom volatility pressure index, designed to incorporate several elements such as VIX volatility, ATM option implied volatility, volatility skew, and term structureThis index demonstrated an upswing as the year came to a close, suggesting increased market sensitivities.

Lastly, the shift in systematic funds’ allocations has caught attention, particularly in light of recent market declines potentially triggering sell-offs by trend-following and risk parity strategiesGoldman’s estimates indicated that in just the past week, such funds had liquidated approximately $28 billion in global equities, projecting further potential sales of another $28 billion in the upcoming week.