Fear of downside risk has nearly vanished, and a core pricing mechanism in the options market is breaking down.
Goldman Sachs derivatives strategist Brian Garrett noted in his latest weekend report that the volatility skew of S&P 500 options has fallen to an 18-month low, with the market pricing the probability of a 10% decline and a 10% rise at nearly identical levels—both around 8%—a phenomenon directly labeled by Goldman Sachs’ volatility team as “Skew breakdown.”
Meanwhile, the Goldman Sachs Fear Index closed in single digits, hitting a two-year low, indicating that demand for hedging against tail risks has fallen to extremely low levels.
This signal emerges against the backdrop of a sustained rally in U.S. stocks. This year, the S&P 500 has set a new all-time high on average every five trading days, and Micron’s stock price surpassed $1,000 for the first time after hours on Sunday.
Garrett admitted that internal team discussions had evolved from “make it stop” in March to “is this still rising?” in May. However, his own stance has shifted from cautiously bullish to increasingly bearish, with clearly outlined reasons for his bearish outlook.
Three bearish signals emerge as market sentiment diverges from fundamentals.
Garrett outlined three primary concerns in the current market.
First, the breadth of market leadership has become extremely narrow. The top ten weighted stocks in the S&P 500 currently account for 40% of the index’s total weight, and all four recent all-time highs occurred amid negative market breadth—a phenomenon that has never occurred before.
Second, the theme is highly concentrated. Since the beginning of this year, the index excluding AI-related stocks from the S&P 500 has underperformed the overall index by 700 basis points.
Third, the price movement closely resembles historical patterns. Garrett notes that the 2026 price action closely matches the price formation from late 1998 to 1999.
Despite bearish voices dominating media headlines and social media, Garrett emphasized that these concerns are not reflected in the pricing of the options market—fear of downside risk has all but disappeared.
Skew breakdown: Downside hedging costs fall to historic lows
Goldman Sachs' Volatility Team provided three key observations from the options market.
First, the S&P 500 volatility skew has dropped to an 18-month low, driven by two factors: the put wings are unusually cheap, while the call wings are relatively expensive.
Second, the Goldman Sachs Panic Index closed in single digits last Friday, reaching its lowest level in two years. This index combines the two-year percentile rankings of VVIX, VIX, Skew, and at-the-money volatility.
Third, and most critically: the market prices the probability of a 10% decline and a 10% increase at exactly the same level, approximately 8% each. This means the options market no longer assigns an additional risk premium to downside risk—the protective function of Skew has effectively ceased to function.
Garrett noted that the direct implication of the above phenomenon is that the current hedging cost is extremely low for investors seeking to hedge correlation risk.
Combine low-cost hedging with a right-tail positioning strategy.
Based on the above analysis, Garrett provided several specific trading recommendations.
For investors who anticipate a shift in market style from concentration to diversification, Goldman Sachs recommends buying RSP (Invesco S&P 500 Equal Weight ETF) relative to SPX outperformance options, with the cost of a 1-month 100% outperformance option approximately 145 basis points; it also recommends purchasing VIX call options as a hedging tool, noting that the term structure for August and beyond is extremely flat, with VVIX closing at 86.
For investors seeking simple downside protection, Garrett recommends directly purchasing S&P 500 put options—given the currently very low put skew, the payout structure is highly attractive.
In addition, Goldman Sachs recommends going long on Bitcoin ETF volatility with a delta-neutral hedge. Garrett notes that Bitcoin has historically behaved like a leveraged version of the Nasdaq, but is currently priced at a two-year low and trades approximately 10 volatility points below SMH.
Fund Flows: Hedge Funds Have Net Bought for Two Consecutive Weeks; Single-Stock ETF Assets Have Doubled
According to Goldman Sachs' latest Prime Brokerage data, hedge funds have posted two consecutive weeks of net buying, at the fastest pace this year, primarily driven by long positioning increases and macro short covering.
Significant sector rotation is evident: financial stocks (down 6% year-to-date) are experiencing net buying, while industrial stocks (up 11.5% year-to-date) are facing net selling.
On the futures side, end-user open interest has rebounded to levels approaching the 2024 highs. The Goldman Sachs team specifically noted that leveraged ETFs are mechanically expanding their balance sheets; CTA strategies are currently near neutral positioning, but systematic strategies exhibit a clear asymmetry toward left-tail events—buying approximately $12 billion in a one-month flat scenario, versus selling approximately $100 billion in a one-month decline scenario.
Notably, the total assets under management of global leveraged and inverse single-stock ETFs have surpassed $60 billion, doubling in just two months—a segment whose scale can no longer be ignored.