No clear election winner? Options markets already preparing for that possibility
Just weeks head of the Trump-Biden showdown, spikes are seen in ‘implied volatility’ forecasts
As if the world isn't crazy enough, options traders are now pricing in more hysteria in the form of a contested presidential election that could last through the end of the year.
Traders who specialize in buying and selling these hedges against risk tell Fox Business that the options markets are signaling the very real possibility that neither President Trump nor Joe Biden will be the clear-cut winner on Election Day, Nov. 3 -- and the controversy over who will take the White House could drag on for months, leading to massive convulsions in stocks.
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The theory that options players are trading on goes something like this: A contested election would lead to swings in stock prices because investors hate uncertainty -- particularly uncertainty stemming from White House policy. (A Biden presidency would lead to massive regulatory changes and higher taxes that stock investors generally abhor, while a second term for Trump would likely mean a continuation of policies that have led to market highs.)
To hedge against that risk, traders are snapping up options that protect against swings in the Standard & Poor’s 500 Index of large company stocks. This buying is showing up in charts showing pronounced spikes in what traders call "implied volatility," or higher options prices after Election Day as proof that investors are preparing for this election uncertainty.
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Of course, there could be several reasons why investors are getting antsy about the future of stocks, given the coronavirus pandemic and the economic uncertainties it has created. And yes, there is always elevated options activity around a big event like a presidential election.
But people who make their living in the options business say they are taking very seriously the notion that, if he loses, Trump won't immediately concede to Biden, or that mail-in voting will delay the final results for an extended period of time.
Andrew DeFeo, head of risk at Optimize Advisors, points to the spikes in volatility of S&P options in December and January — well after Election Day — suggesting a long and contentious recount that will shake the markets for some time.
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To be sure, traders aren't always right in predicting the future; they often miss so-called Black Swan events that come out of nowhere. But options market predictions of volatility surrounding issues in the news — like the financial crisis in 2008 and now a possible contested election — have been pretty accurate.
In other words, the markets may be in for a wild ride.