The biggest risk in the US stock market may not be a drop, but rather short sellers being forced to buy back at higher prices.

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While everyone in the market is worrying about whether US stocks might fall, Goldman Sachs' prime brokerage and trading desk are issuing a completely different warning — the real risk may be a short squeeze triggered by forced short covering.

Latest data from Goldman Sachs Prime Brokerage and Delta One Trading Desk show that the biggest potential driving force in the current market is not fundamentals, but extreme positioning: short positions in US macro products (indices and ETFs) have soared to their highest level in a decade, and nearly 25% of the top 100 S&P constituent stocks show inverted call option skew (similar characteristics to the retail short squeeze frenzy of 2021).

Last week the S&P 500 rose by 0.9%, marking its eighth consecutive week of gains. Despite the market facing inertia selling after Nvidia's stellar earnings and weak economic data (the University of Michigan Consumer Sentiment Index hit a record low), US stocks still demonstrated strong upward momentum.

Moreover, Goldman Sachs trading desk data reveals even more astonishing structural tension beneath the surface: earlier this month, nominal daily trading volume of SPX call options reached $2.6 trillion, about 4% of the index’s market capitalization; hedge funds' long-short leverage in US equities saw the biggest single-week increase in over three years, with net exposure to tech stocks (as a proportion of prime brokerage books) both jumping to a five-year high, at the 100th percentile; the consumer staples sector suffered the largest net sell-off in more than five years, while consumer discretionary saw the fastest net buying in over two months after being sold in 9 out of the past 10 weeks.

Goldman trading desk believes that the core issue in the current market is not the quality of fundamentals, but rather, after excessive short positioning, once covering is triggered, a self-reinforcing upward spiral may form.

Hedge Fund Moves: Total Leverage at 3-Year High, Extreme Divergence in Tech and Consumer Sectors

Goldman Sachs prime brokerage data shows modest net buying in US stocks last week, with long purchases of individual stocks outpacing short selling (ratio of 1.2 to 1). Notably, the total leverage in US long-short strategies recorded the largest single-week increase in over three years, with increased trading activity across all industries.

Tech stocks regain favor: Despite hedge funds continuously selling US information technology stocks over the past month, last week they suddenly switched to the fastest net buying of the sector since mid-March. Both total and net exposure to information technology (as a percentage of US prime brokerage book’s total) hit five-year highs at the historic 100th percentile.

Severe divergence in consumer sectors: Consumer discretionary was sold in 9 out of the past 10 weeks, but last week hedge funds net bought the sector at the fastest pace in over two months (entirely driven by long buying). Conversely, consumer staples saw the largest net selling, with fund managers aggressively shorting, setting a record for largest net sell-off in over five years.

ETF Short Covering: Macro products (indices and ETFs) saw slight net buying. Previously, investors had favored shorting ETFs out of concern for single-stock squeezes, but last week, short positions in US-listed ETFs fell by 4% for the first time in three weeks, mainly driven by covering big tech and large-cap ETF shorts.

Macro & Flows: Real Index-Level Squeeze Risk, Macro Shorts Hit 10-Year High

Goldman Sachs Delta One trading desk notes that despite major Middle East geopolitical headlines, sharp factor volatility, and mixed consumer data, the S&P advanced ahead of the long weekend.

Mixed consumer trends: Strong performers among retail long targets include Ross Stores (ROST) and Amer Sports (AS), while data from bellwethers like Walmart (WMT) and Target (TGT) missed elevated market expectations, though not weak per se. Walmart fell 7% on earnings day, its biggest single-day drop in three years, fueling concerns about consumer weakness. Additionally, May's University of Michigan Consumer Sentiment Index final value hit a historical low due to high oil prices and rates.
Flows become rational: Asset managers and hedge funds ended up as modest net buyers. While funds continue to flow steadily towards the semiconductor/AI sectors, the "frenzy" buying seen in early April has declined sharply.

Goldman Sachs Delta One trading desk believes that index-level squeeze risk is real. Short exposure to US macro products (indices + ETFs) on Goldman’s books has risen above levels seen before the Iran ceasefire, setting a new 10-year high. Goldman attributes it to investor tension about macro factors (Iran/interest rates/oil), but an unwillingness to use single-stock shorts as a hedging tool.

Derivatives Market: Call Option Trading Fever, Inverted Skew Mirrors 2021 Patterns

Call option frenzy dominates the derivatives market. Earlier this month, S&P 500 index (SPX) call options recorded $2.6 trillion nominal trading volume in a single day (about 4% of the index's market cap).

Highlighting the broad squeeze risk further, according to the latest CBOE data:

Nearly 25% of the top 100 S&P constituent stocks show inverted call option skew — this mirrors the skew pattern seen during the 2021 "meme stock" squeeze.

Currently, the market area with the most bullish call option positioning is where sentiment is at its peak fever.

Risk Warning and DisclaimerThe market has risks; investment requires caution. This article does not constitute personal investment advice and does not take into account any individual user’s specific investment goals, financial situation, or needs. Users should consider whether any views, opinions, or conclusions in this article suit their particular circumstances. Investing based on this is at your own risk. ```