By Steven M. Sears
About a week after Donald Trump turned his head, saving himself from an assassin's bullet, President Joe Biden surprisingly terminated his re-election campaign. Vice President Kamala Harris is the presumptive Democratic nominee, but Trump remains the front-runner.
With the battle for the White House in November now clear, prepare for a wave of stock market volatility as investors try to maneuver among various outcomes.
Investors eager to understand Trump's financial mind-set and how that might influence his approach to markets should consider a commercial real estate concept: the loan-to-value, or LTV, ratio, which measures how much of an asset's value is leveraged against debt.
Among the many difficulties facing the next president, few are nastier than this: The U.S. debt-to-gross-domestic-product ratio is about 123%. That affects stock and debt markets, and potentially impedes America's ability to thrive economically.
The GDP-to-debt ratio is akin to a building's LTV ratio. A seasoned real estate operator like Trump understands that debt isn't necessarily bad. It's simply something to manage -- like a construction project, a building's tenancy, and maintenance.
An owner with confidence in his building's future, in the operational abilities of himself and his team, and in his lender relationships might be able to constructively manage a high LTV, and not just because the bank is on the hook if he fails.
A country isn't a real estate portfolio, but America's asset value could increase if industry and jobs return from abroad. Tax incentives to invest in the U.S. could also help, as could reducing regulatory burdens that create needless operational friction.
This interpretation might or might not prove accurate, though it's hard to imagine a tycoon from a multigenerational New York real estate family has stopped thinking like an owner-operator.
Harris, by contrast, would likely continue the regulatory and spending regime of the Biden administration. The tension between the two candidates' approaches as the election nears will likely trigger some volatility in what has been until now a relatively stable stock market.
In anticipation, investors could consider companies that thrive if frazzled investors trade more stocks and options as Trump and Harris articulate their economic and financial policies.
Nasdaq, Interactive Brokers Group, and Intercontinental Exchange -- which owns the New York Stock Exchange -- are all good stock proxies for volatility. Investors tend to trade more when rattled by events, and that generates higher brokerage and exchange transaction fees.
A risk-reversal strategy -- that is, selling a put option and buying a call option with a higher strike price and same expiration -- helps investors harness the phenomenon of stock market volatility exacerbated by politics. The strategy benefits from rising share prices, and positions investors to buy stock at lower prices.
With Nasdaq's stock at $63.13, investors can buy the December $67.50 call for $2 and sell the December $57.50 put for $1. Should Nasdaq stock be at $75 at expiration, the call is worth $7.50. If the stock is below the $57.50 strike price -- which could happen if the volatility thesis is wrong or Nasdaq disappoints investors -- the stock must be bought at $57.50, or the put adjusted to avoid assignment.
During the past 52 weeks, Nasdaq has ranged from $46.88 to $64.25. Shares are up 8.6% this year, compared with the S&P 500 index's 16.5%.
Investors who want to avoid Nasdaq's second-quarter earnings report, scheduled to be released on Thursday, can wait until the event is over, as it could alter pricing dynamics. The presidential volatility thesis is going nowhere, and there is a long time between now and the November election.
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(END) Dow Jones Newswires
July 26, 2024 21:30 ET (01:30 GMT)
Copyright (c) 2024 Dow Jones & Company, Inc.
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