The Tell: As stocks recover, Goldman sees ‘lowered bar’ for volatility’s return

The U.S. stock market has largely recovered since the correction it suffered in early February, but those gains could mean investors are failing to appreciate the potential for volatility returning to the market.

According to Goldman Sachs, option prices for the average company in the S&P 500 dropped by 10% in the latest week, a period that coincided with an upward move for stocks. The S&P 500 SPX, -0.53%  rose 1.6% over the past week, while the Dow Jones Industrial Average DJIA, -1.06%  added 0.8% and the Nasdaq Composite Index COMP, -0.40%  gained 1.8%, hitting multiple records over the period.

The changes in options pricing suggests “an incrementally more complacent backdrop for stocks,” wrote Katherine Fogertey, a Goldman options strategist, who added that there was a “lowered bar for volatility.”

That lowered bar could easily be hurdled in the coming weeks, especially for stocks in the health-care sector, the investment bank wrote, noting the “number of important stock catalysts on the horizon,” including analyst days and other news events.

Goldman sees catalysts for a number of names in the sector, including Dow component Merck & Co. MRK, -0.51% along with Bristol-Myers Squibb Co. BMY, +0.21% Mylan N.V. MYL, -1.06% and Incyte Corp. INCY, +0.56%  , among others.

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For Merck, Goldman recommended buying straddles ahead of medical conferences scheduled to occur in both April and June, when it could release data on a closely watched lung-cancer drug. A straddle is an options strategy where an investor buys a bullish call option and a bearish put option at the same strike price, betting that a stock will move by a certain amount, rather than in a particular direction. It is essentially a bet on stock volatility, which Goldman sees the potential for as Merck details developments with its drug pipeline.

Good drug news “could translate to $4-$5 in upside for [Merck] shares,” Goldman wrote, a target that could translate to upside of as much as 9% from current levels. However, disappointing news on this front creates “potential for MRK shares to be weak.”

Goldman also recommended buying a straddle on shares of General Electric Co. GE, -0.69%  , which have been extremely volatile — primarily to the downside — amid a myriad of issues, culminating in the industrial conglomerate halving its dividend and giving a downbeat profit outlook.

“Our analyst notes that over the next few weeks GE could announce a new board, shed more light on the SEC investigation and provide restated 2016/2017 financials,” it wrote.

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