Concerns regarding a flood of mail-in ballots overwhelming the system and taking days or weeks to count have caused investors to price in outsized volatility lasting up until the Jan. 20, 2020 inauguration.
But a delayed outcome is just a “tail risk” with a low probability of occurring as vote counting rules vary significantly by state and should give markets enough information to be able to determine a likely winner, according to Michael Cahill and Alec Philips, analysts at Goldman Sachs.
“In other words, the S&P can trade the likely outcome, even if the AP does not call the race,” they wrote.
Investors worried the election winner won’t be known for weeks or months, possibly right up until Inauguration Day, have driven up the cost of hedges against such an outcome.
Monthly pricing for volatility contracts in S&P 500 futures typically trade with a spread of a tenth or a quarter of a so-called vol point from one contract to the next. Last week, however, there was a spread of six points between September and November, climbing from 17.5 to 23.5. It was up to 24 for January.
Similar outsized pricing has occurred in the U.S. Treasury market, where volatility is six times higher than normal. Ahead of the 2016 election it was three times its usual level and double the norm before the 2012 and 2008 votes.
"A lot of surprises are kind of built into these volatility levels around the election," Anthony Saliba, CEO of the Chicago-based Matrix Execution Group, an executing broker-dealer that specializes in options and equities, told FOX Business last week.
Like the Goldman Sachs analysts, Saliba believes it’s possible we know the winner on election night.
Such an outcome would “take the air out of volatility,” he said.
While Goldman believes markets should have an indication of a winner on election night, or shortly thereafter, the firm warns there are a few caveats to its analysts.
A number of states are trying to change the rules in regards to how long ballots received after Election Day can be counted. Others, including battlegrounds Michigan and Pennsylvania, are making efforts to begin the ballot-counting process sooner.
Additionally, even if a winner of the presidential election is known, Cahill and Philips said it may be more difficult to determine the winners of Senate races.
Legal challenges in states are a “fairly small tail risk,” according to the analysts, as they would require a small margin of victory within both the Electoral College and the specific state.
While we recognize that an especially uncertain election outcome could have a significant impact on risk sentiment, we think this outcome is less likely than current market pricing – and client conversations – seem to imply,” they wrote.