In the lead-up to a highly competitive U.S. election perceived as a toss-up, options traders are actively mitigating risk and preparing for potential market fluctuations. Throughout October, equity options volatility has risen, despite relatively subdued market movements, driven by concerns not only about the impending election but also the ongoing earnings season and a pivotal interest rate decision from the Federal Reserve. The contest between Kamala Harris and Donald Trump remains too close to call as voters head to the polls.
Since the Federal Reserve cut interest rates in September, bond yields have increased, prompting investors to retreat from certain futures positions while incorporating tail-risk hedges in anticipation of rising rates. Currency traders, on the other hand, are predicting greater volatility, as evidenced by increasing fluctuations in the yuan, Mexican peso, and euro, driven by uncertainties surrounding trade policies and tariffs. On Monday morning in Hong Kong, futures for the Cboe Volatility Index (VIX) dipped by 1.4%.
“After several weeks of de-risking leading up to the election and the Fed meeting, positioning is looking quite clear,” remarked Stuart Kaiser, a U.S. equity trading strategist at Citigroup Global Markets Inc. “This is beneficial for risk/reward scenarios post-election, depending on the outcome. Currently, bonds are exhibiting more movement compared to stocks.”
Here’s an overview of how options traders are positioning themselves across various asset classes, including equities and cryptocurrencies:
As anticipated, much of the hedging related to the election has occurred at the last minute, with shorter-term options allowing for more agile positioning closer to the event. Implied volatility has significantly outpaced realized volatility, indicating that investors are bracing for potential market swings, even as the S&P 500 Index experienced 29 consecutive sessions without a decline exceeding 1%.
“There has been a noticeable uptick in interest for trades related to the election in recent days,” stated Daniel Kirsch, head of options at Piper Sandler & Co. “Investors predicting a Trump victory are increasing their exposure to financial and crypto stocks, while those favoring Harris are purchasing options on renewable energy stocks. Additionally, there’s been a surge in hedging, with many traders opting for put options on the S&P 500 and QQQ ETF.”
Short-term implied volatility for the S&P 500 has spiked relative to one-month levels, as the election and Federal Reserve deliberations influence the shorter-term measure. The Cboe VVIX Index, which gauges the volatility of the VIX, is also elevated.
“Currently, the options skew is steep, and the VIX is significantly higher than realized volatility, indicating that the market is well-hedged at this stage,” commented Zhiwei Ren, a portfolio manager at Penn Mutual Asset Management.
Despite elevated volatility levels, projections suggest a modest 1.7% move for the S&P 500 the day after the election, aligning with historical averages for previous elections. This implied movement has steadily declined from a peak of approximately 2% in early October.
In specific sectors such as cryptocurrencies and clean energy, volatility is well above historical averages. Recent data from Morgan Stanley revealed that crypto stocks are anticipating nearly 10% swings, while renewable energy firms are seeing expected moves of around 6%. For instance, over 20,000 call spreads for November were purchased last week in Sunrun Inc.
Once the election concludes, favorable market dynamics are expected to foster a rally as hedges are lifted, mutual fund buying increases in November, companies engage in share repurchases, and declining volatility encourages systemic buying and re-hedging by options dealers.
“Assuming a smooth transition post-election, we anticipate that these hedges will unwind, potentially leading to a sharp decline in the VIX and a flattening of the skew,” Ren added. “If both occur, it could attract additional buyers to the market and drive prices higher.”
In the foreign exchange market, short-term currency options are reflecting heightened risks surrounding the election, with implied volatility surging in anticipation of significant market movements following the U.S. vote. One-week volatility for the dollar-yuan pair reached unprecedented levels late last week as traders prepared for potential escalations in U.S. tariffs under a Trump administration, which could adversely impact China.
Euro volatility has risen sharply, the highest it has been since March 2023, amid fears of possible trade tariffs resulting from a Trump win. Additionally, one-week volatility for the peso has climbed to its highest level in over four years, with its premium for longer-term expectations widening to the highest since Bloomberg began tracking this data in 2007.
In recent weeks, positioning in the Treasury market has shifted towards traders reducing their leverage in futures, primarily through long liquidations, amid rising anticipation of post-election fiscal stimulus that could increase the supply of Treasuries. Consequently, open interest in 10-year note futures has plummeted since early October as yields have risen.
This de-risking behavior is mirrored in the cash market, where a recent survey from JPMorgan Chase & Co. indicates that clients are cutting both long and short positions, while neutral positions have increased. In the Treasury options market, tail-risk hedges are being positioned at higher yields, anticipating a more significant selloff in the bond market than current levels suggest. Notably, the December 10-year put option at 109.50 corresponds to a yield of approximately 4.5%, about 25 basis points above current levels.
“The election-related volatility premium is most pronounced in the bond market concerning long-term rates, reflecting concerns about heightened fiscal risks associated with a sweep outcome,” noted Tanvir Sandhu, Bloomberg Intelligence’s chief global derivatives strategist. “The skew indicates a demand for hedges using payer swaptions against a potential selloff in long-term rates.”
Cryptocurrency traders are taking divergent stances ahead of the election, with the options market shifting from a previously bullish outlook to a more hedged stance. Implied volatility for short-term contracts, such as 14-day puts, has increased significantly, while calls with the same expiration have remained steady, according to data from crypto liquidity provider B2C2.
Despite the lack of a clear directional bias amidst rising volatility leading into the election, the increasing premium for calls across longer tenors, along with Bitcoin futures on CME, suggests a bullish outlook for the post-election period, buoyed by expectations of further rate cuts and favorable changes in cryptocurrency regulations in the coming year.
Binary options, which provide payouts based on the fulfillment of specific conditions, such as a currency and a stock reaching predetermined levels, have gained popularity as a hedging strategy around major events like the election. According to Esmail Afsah, a derivatives strategist at JPMorgan, such trades have surged as investors adopt firm views on how individual assets will respond to the election outcomes.
“I suspect this uptick is largely due to investors having strong opinions on the potential behavior of various assets across the four key scenarios stemming from the U.S. election,” Afsah commented. “Employing hybrid options and betting on the direction of two assets concurrently allows for significant leverage, enhancing the likelihood of favorable outcomes, provided the assets perform as anticipated.”
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