By Amrith Ramkumar and Julia-Ambra Verlaine
Sept. 28, 2020
Investors are betting on one of the most volatile U.S. election seasons on record, wagering on unusually large swings in everything from stocks to currencies as they brace for what could be a weekslong haul of unpredictable events.
The bets go beyond the Wall Street hedging that typically precedes an election. Traders are scooping up a variety of investments that would pay out if volatility extends far beyond Election Day itself, concerned that the outcome of the presidential contest could remain unclear into December.
Whether fueled by a slow or contested counting process, futures and options prices show that an ambiguous election result is now the stock market's baseline expectation, while those tied to Treasurys and gold are signaling one of the most active Novembers on record, traders said. Derivatives tied to the Japanese yen, a haven currency that investors use to protect against downturns, are also reflecting much more anxiety than they did four years ago.
Some traders are using investments tied to the Cboe Volatility Index, or VIX, that offer protection if stocks gyrate for weeks after Election Day. A measure of expected swings in the S&P 500, the VIX has climbed steadily lately. But the nature of the rise stands out: VIX futures cost more going into the end of the year and less early in 2021, a sign investors are fearful of turmoil that lasts into December.
Futures require the holder to buy or sell an asset at a specific future date, and options are similar but grant the owner the choice to do so without obligation.
In another hedge against volatility, currency traders are also scooping up longer-dated "straddles." These involve buying both bullish options known as calls and bearish options called puts. The strategy lets holders protect against big swings in both directions. Traders profit if the underlying currency climbs or drops from the strike price—the price at which options are exercised—enough to exceed the total amount paid for the options.
Elections have historically been overshadowed by broader economic trends and interest rates in driving market performance. And financial advisers often teach clients to discard politics when making investment decisions. But so much anxiety appearing in seemingly unrelated investments ahead of the election tells some analysts that markets are gearing up for an especially rocky period, one that could be even more painful if the recent rallies in various asset classes unravel at the same time.
"It is being priced as one of the most volatile expected events of all time," said Mike de Pass, global head of Treasury trading at Citadel Securities.
The election uncertainty is coalescing with fading hopes for additional economic stimulus from Congress and anxiety about fresh coronavirus restrictions in parts of the country, dragging down stocks after a monthslong rally. The S&P 500 notched its fourth straight weekly decline Friday, dropping nearly 8% below its Sept. 2 record. Volatility is also rising in currenciesand commodities.
Investors this week will monitor the September jobs report for the latest gauge of hiring in the U.S. Many analysts were surprised the S&P 500 rose for much of the summer even as the economic recovery cooled and say markets are finally experiencing a long-awaited pullback.
"We're slightly more defensive now through the election period and the weeks beyond just until the clarity is there," said Mona Mahajan, senior U.S. investment strategist at Allianz Global Investors, which has generally been holding more cash across its portfolios.
Perhaps the clearest example of the worry is found in VIX futures. A similar phenomenon has occurred in currencies, where so-called volatility curves that measure the difference in price between options at various points in time indicate investors are concerned about swings long after Election Day.
Investors typically buy options to protect themselves from immediate jolts in asset prices, pushing up overnight or short-term contracts around the election. This was the case in 2016, when President Trump's surprising victory briefly swung markets, then stocks began an unexpected monthslong climb.
While overnight derivatives tied to the Japanese yen are nearly four times more expensive on election night than now, currency traders are also scooping up longer-dated protection through straddles and other strategies.
"In 2016, we saw event risk in yen options contained to one day," said Jeff Yarmouth, global co-head of foreign exchange flow derivatives trading at UBS Group. "This time around, it's prolonged to roughly the end of November."
Elevated trading activity in other havens like gold and Treasurys underscores political concerns. Gold has risen about 23% this year and hit record highs last month, and bullion futures that expire in December after the election have been the most heavily traded by investors for several weeks now. Keith Lerner, chief market strategist at Truist/SunTrust Advisory, holds gold in the firm's global exchange-traded fund strategy in part because of election uncertainty.
Investors are also buying derivatives linked to specific geopolitical risks. Aroop Chatterjee, head of macro foreign exchange and emerging market research at Barclays, said options are signaling that the Russian ruble will be among the most volatile currencies around Election Day. Some traders said bets on the ruble have increased because of perceived policy risks around sanctions if Democratic nominee Joe Biden is elected, even though the currency normally isn't as active around elections as others.
"Specific currency pairs not as correlated with U.S. election uncertainty have become more important during this election cycle," said Mr. Chatterjee.
So many investors preparing for volatility actually gives some analysts confidence that this year's surprising market rally could continue, particularly if the presidential and congressional elections go more smoothly than expected. Stocks, bonds and commodities rose in tandem for weeks this summer even as coronavirus concerns lingered, highlighting how upbeat momentum can often overshadow market risks.
"Part of the problem is the markets don't know what to do about the election," said Gershon Distenfeld, co-head of fixed-income at AllianceBernstein. "We have all been humbled in prognostications of markets given recent experiences."
Write to Amrith Ramkumar at email@example.com and Julia-Ambra Verlaine at Julia.Verlaine@wsj.com
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