Wall Street Journal Associate Editor-in-Chief John Bussey is looking forward to the upcoming election, polls and ’embarrassing’ Trump voters.
The presidential election is three months away, but some traders are preparing for the possibility that prolonged political uncertainty could stifle the stock market.
Investors are moving beyond normal hedging ahead of a potential change of power in Washington. Instead, they bet on volatility and a possible tumble later in the year. Among her concerns: President Trump could try to delay the election or restrict sending of mail-in, as well as the chance that a result weeks after the polls close remains unclear.
Concerns about the election reinforce existing concerns about the weak economy, a possible second wave of coronavirus infections in the fall and the fledgling market. The bearish bet is that unrest around the election will hit the already fragile economy, as the cooler months pile up more infections, all hitting the stock that is priced for a recovery. The S&P 500 is 4.4% advanced this year to close Friday 3372.85. Recovering from its low in March has driven the best 100-day stretch since 1933.
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Eric Metz, chief investment officer at investment firm SpiderRock Advisors, has applied for stock options trading for clients who would benefit if the S&P 500 drops to 25% from its current level early next year. The hedge includes one double put option to buy tied to the S&P 500 when selling another. Concerns about the broader economy and the recent rally of stock markets are also raising interest in such trades, he said.
“We are focusing on January,” Mr Metz said. “Give yourself a little more time … be careful of any unforeseen or unknown things that might happen.”
In this March 16, 2020 stock photo, trader Peter Tuchman works on the floor of the New York Stock Exchange. (AP Photo / Craig Ruttle, file)
The market’s main driver at the moment is the economy and uncertainty of a new incentive package in Washington, which could hurt the recent slow recovery in retail sales and jobs. Next week, traders will follow new data on jobless claims and home sales, although many expect light trading volumes by the end of the month.
Paul Britton, founder of Capstone Investment Advisors LLC, said his firm has used derivatives tied to a popular measure of expected volatility, the Cboe Volatility Index, or the VIX, as well as options contracts, to bet on volatility by the end of the year. years in one of their strategies. His clients, which include expenses and pension funds, have sought insurance-like actions to protect against a downturn.
“You always get this interest ahead of an election,” said Mr. Britton, whose company is one of the largest specializing in trading volatility, controlling about $ 7 billion in assets. “You’ve got more 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 be no clear election winner. “The real uncertainty that investors may face is when there are material concerns about the legitimacy of the process of deciding a winner,” Bridgewater told customers. “Given the personality of President Donald Trump, his statements about the possibility of fraud, and the relatively untested and unclear process of reaching resolution, it is a possibility in our minds.”
A Bridgewater spokesman declined to comment further.
Some of the biggest option positions on the S&P 500 would benefit if the index falls by December, according to data provider Trade Alert. These include bearish put option contracts approaching a strike – if the level at which the contracts can be exercised – of 2500 or 2000, at least a 26% drop from Friday’s closing level of 3372.85.
President Trump speaks at a news conference in the James Brady Press Briefing Room at the White House, August 13, 2020, in Washington. (AP Photo / Andrew Harnik)
Call options give the right to buy shares at a certain price, later in time. Put options give the right to sell. Traders can tap options to create directional laws or hedge portfolios.
To take advantage of a rocky presidential election, RBC Capital Markets recently recommended investors buy bullish options that expire in January on one of the largest exchange-traded funds that follow gold. Analysts at Goldman Sachs Group Inc. said in a July note to clients that they prefer to put up hedges that expire in December because of the prospect of delayed election results, pointing to the 2000 match between Democrat Al Gore and George W. Bush when the fate of the race was unclear until December.
Markets tend to be volatile before the elections, and October and November are at least the wildest months of the year. The VIX has risen an average of about four points since its inception for the past seven elections.
Fear surrounding the election appears even more intense this time around. Investors are paying more for VIX futures tied to October than September than they have in the past four election cycles going after 2004, according to Stuart Kaiser, head of derivatives research at UBS Group AG. This extra premium is more than double what it has historically been, UBS data shows. These derivatives deal with the upcoming November 3 election.
The fear is evident in the market for VIX derivatives that go out after 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 for the unknown brace. That relationship has reversed slightly around the beginning of the year, indicating that traders expect more volatility around January than in the following months.
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Meanwhile, gold prices have recently risen to records, driven higher by investors nervous about the world economy. Some of the largest option positions proposed tied to the $ 78 billion SPDR Gold Trust are bullish calls that expire in January, a bet that the exchanged-traded fund will jump another 10% to $ 200 or $ 235, according to data from Trade Alert.
Jack Ablin, chief investor at Cresset Capital in Chicago, says he is looking for ways to hedge against post-sectional chaos. Mr. Ablin focuses on structured notes, which are custom investments sold by banks that promise to protect the original investment while providing some potential upside. However, there may be high fees and other restrictions related to these products.
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He also buys a series of put contracts, as options that yield profits when 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 protection against harm,” says Mr Ablin. “The possibility of a contested election could wreak havoc in both the country and our financial markets, as Americans question the viability of our nation’s democratic process.”
