Published Date: 2020-09-15 | Source: INCE|Community | Author: Viv Govender
Futures on the Volatility Index (often called the VIX) are showing an unusual pattern in terms of their pricing. If you were to compare the price of futures expiring at the end of October to those expiring in November, you'll see a noticeable jump in premiums. This indicates investors foresee an event occurring in November that will significantly impact the market. The event in question is most likely the US elections, which is scheduled to occur on the 3rd of November 2020.
At first glance, this may seem ridiculous. Certainly, this is likely to be a highly contentious election but once the results are in, the uncertainty should end almost immediately. However, on closer examination, there are a few reasons to be concerned...
First let's look at history.
Will we see a repeat of the 2000 elections?
Though the US elections have generally been stable events, 20 years ago an election occurred that could easily have snowballed into something worse. To understand what happened it would be best first understand how the US presidential election works.
US citizens don't vote directly for the president, rather they vote via their States. This is done through an electoral college. Each state is apportioned a certain number of electoral votes according to the size of their population. Most states have a winner-takes-all system. So even if you win the state by just one vote, you get all that State's electoral college votes. This is further complicated by the fact that smaller states get a larger proportional number of electoral college votes than their population would dictate.
So technically it's possible for a presidential candidate to get more individual votes but still lose via the electoral college. And that's exactly what happened in 2000...
Al Gore won the popular vote but lost the electoral college. Even worse the whole election came down to just 537 votes in Florida. Less than 0.01% of the votes counted, just in Florida, and an even smaller percentage of the votes for the entire election.
Luckily, back then, the animosity between the two parties was not as bad as it is now. Eventually Al Gore conceded the election. In the current environment such congeniality would be surprising to say the least.
Two more factors that could increase volatility around the US elections
Secondly, the virus has meant that we are likely to see a massive increase in the number of people voting by mail. This is significant because Democrats appear to be more willing to vote via mail and mail-in votes are often counted in later than in-person votes. This means that you could very easily see a scenario where Trump is ahead initially, but Biden is eventually declared the winner days later.
Finally, the current candidates for the Presidency are among the oldest to ever run for office. There is a definite possibility that we could see one of them suffer some sort of health event before or around the time of the election. We have already seen speculation that Biden is suffering from some sort of cognitive decline and Trump had to come out a few weeks ago and deny that he had suffered from a stroke.
Why the election debates could be key to anticipating future movements on the VIX
Overall, the potential for the election to act as a disruptive event is high.
But there is one caveat, much of this uncertainty will evaporate in the face of a landslide win by either candidate. Right now, it would seem Joe Biden is heading for just such a victory. He is leading Trump by almost 10% in many national polls.
The next key event for election watchers will be the debates that start at the end of this month. If Biden can hold his own, I would expect volatility pricing to begin to return to normal and the market to calm down rapidly.
What does this mean for your portfolio? And is there potential for you to profit?
All this may sound academic, but there are ways to profit from such a shift in volatility.
At Rand Swiss, we offer direct access to international markets so you can speculate directly on VIX contracts. You can make a bet that volatility will either rise of fall depending on your view.
Remember, volatility is one of the inputs required when pricing options. Any option structure will be affected by the movement of volatility. If you're currently using options to hedge your portfolio you're welcome to contact us on firstname.lastname@example.org and we'd be happy to take you through the potential portfolio impact given different scenarios.