November Spawned a Monster (Election Volatility)

by CC November 1, 2016 3:52 pm • Trade Updates

The VIX (CBOE Volatility index) recently touched the fairly low level of 13 on October 24th. Since that day, it has seen seven straight up days and is now above 20 on today’s nearly 20% spike higher. That’s with a move lower in the SPX since Oct 24th that hasn’t even reached 2.5% yet (as I write) Although we see a FOMC statement tomorrow, it’s largely seen as a nonevent where the chances of a rate hike are close to zero. The only interesting thing traders will be looking at is language within the statement for hints about December and beyond. But the VIX has been acting funny anyway, even going upon some of the past few days where the overall market has seemed stuck in the mud. The culprit? Uncertainty about the upcoming election that was being more reflected in the VIX than the SPX, until today. From Bloomberg, earlier today:

Uncertainty surrounding the US presidential election appears to be the culprit. According to Fed Funds, there’s only a 16% chance of the Fed raising rates on Wednesday. Based on the last 3 years data, the SPX 1 month implied to realized volatility spread is trading at the 99th percentile.

That relationship between realized and implied vol is closing a bit today with this more than 1% move lower in the SPX. But the point remains, election polls have tightened, swing states don’t seem as obvious as they were 2 weeks ago, and Clinton is currently dominating the new cycle so there’s an assumption this tightening trend could continue into next week. The market doesn’t like uncertainty.

Back on September 8th we highlighted the potential for volatility into early Nov and isolated the Fed meeting and the election with a trade idea in VIX futures. Here was the trade and some rationale:

*VIX ($12.25) Sell the Nov 15 put to buy the Nov 20/29 call spread for even money
  • Sell 1 Nov 15 put at 1.00
  • Buy 1 Nov 20 call for 1.70
  • Sell 1 Nov 29 call at .70

We like the idea of looking out a few months and establishing a position in the VIX options where a large spike could be very profitable, whereas a continuation of this trend lasting into year end risks just a little and has a high likelihood of ending up with no losses or gains. In other words, a good things for those that would like to profit from a spike in volatility against possible losses in stocks if the market takes a downturn. (this is not a perfect hedge against a long portfolio, but it is a trade that would be profitable.)

With the spot VIX now near 20, this trade is worth about .75 mark to market vs the even money initial cost basis. More importantly the 15 put strike is fairly safe for now (it’s the risk you take in this trade being short that put) with the Nov VIX futures (what these options are based on) now above 18.

That leaves this trade a little wiggle room because it’s not the type of trade you do to try to make .75 (the current mark to market profit). So how do we plan on managing this trade? By watching the polls!

But which polls? Right now the race has tightened nationally but it’s still Clinton’s to lose in the electoral college. And those are the polls you should be watching, aggregate, and state only at this point. Ignore the noise around some new national poll from an individual outlet. (for example, ABC’s just moved 13 points in the last week, there’s no way that’s important data either when Clinton was up 12 last week and probably means that Trump isn’t up 1 now and the truth lies somewhere in the middle)

Here’s today’s Real Clear Politics electoral map with no toss-ups (meaning even 1 point state leads are put into the column of that candidate):


The biggest change to this map as the polls have tightened in the past week has been Florida and Ohio going red. But as you can see, even with that Clinton stands at over 300 electoral votes. The states to watch beyond FL and OH as we get more polling (especially after the FBI email letter to congress and the headlines about Obamacare rate increases) are North Carolina, Colorado, Arizona and Nevada. How do those states look right now? Let’s go to Tiger Beat on the Potomac (Politico) for some state poll aggregates:


As you can see, Clinton holds small leads in North Carolina and Nevada and Trump holds even smaller leads on Ohio and Florida. But go back to that map above from RCP and you’ll see that Trump’s path to victory is much harder electorally. Even if he wins Ohio and Florida and sweeps the swing states of NC, NV, and AZ he still is only at 265 electoral votes when he needs 270.

So that’s what you should be watching for if you think this election is still in the air. What other state does Trump flip to get to 270? Pennsylvania and Virginia seem out of the question. Colorado? That’s where I live. God help us all. (side-note, Colorado does mail in ballots so a large percentage of voters here, including myself, have already voted)

Of course, if the polls start to stabilize and it looks like states like Colorado (or one out of the blue unlike past cycles like Wisconsin) look like a no go for Trump, you can already have a pretty good sense of how this election will unfold before most of your friends and many market participants. In that case, that also effects trade management on trades like the VIX above.

We’ll be keeping an eye on the polls in relation to this trade and will update on the site in the coming days.