Traders brace for markets out of whack around presidential election

The presidential election is three months away, but some traders are bracing for the possibility that prolonged political uncertainty could fuel stock market chaos.

Investors are going beyond normal coverage ahead of a potential power shift in Washington. Instead, they bet on volatility and a possible fall in the markets later in the year. Among their concerns: President Trump could try to delay elections or disrupt postal voting, as well as the possibility of a result remaining unclear for weeks after polling stations close.

Election concerns amplify existing concerns over a weak economy, a possible second wave of coronavirus infections in the fall and the highflying market. The bearish bet is that the turmoil over the election is hitting the already fragile economy as the colder months bring more infections, all hitting the stock market which is forecasting a recovery. The S&P 500 rose 4.4% this year to close at 3,372.85 on Friday. Its recovery from its March lows fueled the best 100-day streak since 1933.

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Eric Metz, chief investment officer of investment firm SpiderRock Advisors, operated an equity option trading for clients who would profit if the S&P 500 fell 25% from its current level until the start of the year. next year. Hedging involves buying a bearish put option linked to the S&P 500 while selling another. Concerns about the economy as a whole and the recent rebound in the stock market are also fueling interest in such transactions, he said.

“We are focusing on January,” Metz said. “Give yourself a little extra time … be careful of any unforeseen or unknown things that might happen.”

In this March 16, 2020 file photo, trader Peter Tuchman works on the floor of the New York Stock Exchange. (AP Photo / Craig Ruttle, file)

The main driver of the market right now is the economy and the uncertainty of a new stimulus package in Washington, which could hurt the slow recovery seen recently in retail sales and employment. Next week traders will follow new data on jobless claims and home sales, although many expect light trading volumes through the end of the month.

Paul Britton, founder of Capstone Investment Advisors LLC, said his company uses derivatives linked to a popular gauge of expected volatility, the Cboe Volatility Index, or VIX, as well as options contracts, to bet on volatility up. ‘at the end of the year in one of its strategies. Its clients, which include endowments and pension funds, have sought insurance-type trades to protect against a downturn.

“You always get that interest before an election,” said Mr Britton, whose company is one of the largest specializing in trading volatility, overseeing around $ 7 billion in assets. “You have a greater interest because of the added uncertainty.”

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Bridgewater Associates, the giant hedge fund with $ 140 billion in assets, told clients last month that it believes there is a risk that there will not be a clear election winner. “The real uncertainty that investors might face is whether there is a material concern about the legitimacy of the winner selection process,” Bridgewater told clients. “Given the personality of President Donald Trump, his statements about the likelihood of fraud, and the relatively untested and unclear process for reaching a resolution, this is a possibility in our minds.”

A spokesperson for Bridgewater declined to comment further.

According to data provider Trade Alert, some of the largest open option positions on the S&P 500 would profit if the index plunges through December. These include bearish put option contracts indexed to a strike – or the level at which contracts can be exercised – of 2,500 or 2,000, at least a 26% drop from Friday’s close level of 3372, 85.

President Trump speaks during a press conference in the James Brady Press Conference Room at the White House, August 13, 2020, in Washington. (AP Photo / Andrew Harnik)

Call options give the right to buy stocks at a specific price, later in time. Put options confer the right to sell. Traders can exploit options to make directional bets or hedge portfolios.

To take advantage of a turbulent presidential election, RBC Capital Markets recently recommended investors buy bullish options that expire in January on one of the largest exchange-traded funds that track gold. Goldman Sachs Group Inc. analysts told clients in a July note to clients that they preferred to put in place covers expiring in December due to the prospect of delayed election results, highlighting the 2000 contest between Democrat Al Gore and George W. Bush when the fate of the race was not clear until December.

Markets tend to be volatile before elections, and October and November are the craziest months of the year anyway. The VIX has grown on average about four points ahead of the last seven elections since its inception.

The fear surrounding the election seems even more intense this time around. Investors pay more for VIX futures linked to October than to September than they did in the last four election cycles dating back to 2004, according to Stuart Kaiser, head of equity derivatives research at UBS Group AG. This additional premium is more than double what it was historically, according to UBS data. These derivatives cover the upcoming elections on November 3.

The angst is evident in the VIX derivatives market which will be released until January, well after election day. Typically, futures contracts that expire later in time are priced higher than those that expire in previous months, as investors prepare for the unknown. This relationship was reversed slightly towards the start of the year, indicating that traders expect more volatility around January than in the following months.

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Meanwhile, gold prices recently hit record highs, pushed higher by investors nervous about the global economy. Some of the largest open option positions linked to the $ 78 billion SPDR Gold Trust are bullish calls expiring in January, a bet the exchange-traded fund will rise 10% to $ 200 or $ 235, according to data from Trade Alert.

Jack Ablin, chief investment officer at Cresset Capital in Chicago, says he’s looking for ways to protect himself from post-election chaos. Mr. Ablin focuses on structured notes, which are personalized investments sold by banks that promise to protect the original investment while offering upside potential. However, there may be high fees and other restrictions associated with these products.

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He also buys a series of put contracts, or options that pay a profit if the market falls, traded on Cboe Global Markets Inc., while selling contracts that bet on a market rise.

“We sell upside opportunities in exchange for downside protection,” says Ablin. “The possibility of a contested election could wreak havoc both in the country and in our financial markets, as Americans question the viability of our nation’s democratic process.”