Some traders see opportunity in Wall Street's election-related anxiety

Dow Jones02:21

MW Some traders see opportunity in Wall Street's election-related anxiety

By Joseph Adinolfi

Late last week, traders piled into bets that Wall Street's 'fear gauge' would decline

Wall Street is still on edge ahead of Tuesday's U.S. election. But some traders appear to be getting a head start on bets that a relief rally will take hold once the vote tallies are known.

To wit, trading in put options tied to the Cboe Volatility Index VIX, known as Wall Street's "fear gauge," soared on Friday relative to trading in call options. A barometer that measures activity in puts compared with calls tied to the index hit its highest level in four years as a result, FactSet data showed.

That means a number of traders are betting that the VIX will fall during the weeks ahead, although open interest in VIX calls is still greater than open interest for puts.

Some of this late-week surge was likely due to another major event for markets, the October jobs report, having come and gone without challenging the Federal Reserve's view that a cooling labor market demands lower interest rates.

But signs that Democratic candidate Kamala Harris has gained a last-minute edge in the polls likely also helped to brighten options traders' mood, according to Charlie McElligott, a cross-asset strategist at Nomura.

According to McElligott, a Harris victory with a divided Congress would be the most bullish election outcome for markets, acting as a "volatility killer" for both stocks and bonds.

Treasury yields BX:TMUBMUSD10Y have been climbing since the Fed delivered its jumbo interest-rate cut in September. Their rise, driven by concerns about U.S. deficit spending and fears about a potential re-acceleration of inflation, has helped push the ICE BofAML MOVE Index to its highest level since October. The gauge measures expected volatility in the bond market, fulfilling a similar function to that of the VIX for stocks.

Outside of the VIX complex, options traders remained very much on edge ahead of Tuesday's vote. The VIX itself was rising on Monday, as the S&P 500 SPX continued to slide after booking a second straight weekly loss on Friday. The VIX stood at 22.44 in recent trading, according to FactSet data, while the S&P 500 was down 0.2% at 5,719. The level of the VIX is determined by trading activity in options tied to the S&P 500 that are set to expire in roughly one month.

The MOVE index has retreated since last week but remains near its highest level since October 2023, LSEG data showed.

So-called put skew, which measures demand for out-of-the-money puts tied to the S&P 500 compared with demand for at-the-money contracts, has continued to climb, McElligott said, suggesting investors are still placing a premium on contracts that could shield portfolios from a sharper selloff.

What's more, the VIX's sensitivity to moves in the S&P 500 has been unusually high lately. And the Cboe VVIX, which reflects demand for options contracts tied to the VIX, remains near its highest level since August, FactSet data showed.

Ultimately, all of this stress could help create a springboard for markets to move higher once the risk has passed, according to McElligott, who shared his views in commentary emailed to MarketWatch on Monday.

Of course, there are no guarantees in markets, as in life. Stocks could still slide if a "blue sweep" becomes a reality, McElligott noted.

Such an outcome would enable a Harris administration to pursue tax hikes, regulation and other policy priorities that would likely be anathema to markets.

But polls suggest this remains unlikely, with key Senate races continuing to favor Republicans, McElligott said.

A victory by former President Donald Trump, either with or without unified Republican control of Congress, would likely lead to a more hawkish Fed, given Trump's preference for fiscal policy to continue to "run hot."

Prices for out-of-the-money call options remain much more reasonable than puts, meaning there is still plenty of opportunity for traders looking to chase the rally via options, McElligott said.

McElligott believes sophisticated funds, including those that run so-called "volatility control" strategies, will re-up their exposure to stocks as the election passes and the VIX falls.

That should help to catalyze a rally in November and December similar to what has often taken place during election years.

McElligott isn't the only one who expects a late-year "melt-up" for stocks. Strategists at Goldman Sachs Group, UBS Group and others across Wall Street expect stocks to continue climbing into the end of the year.

-Joseph Adinolfi

This content was created by MarketWatch, which is operated by Dow Jones & Co. MarketWatch is published independently from Dow Jones Newswires and The Wall Street Journal.

 

(END) Dow Jones Newswires

November 04, 2024 13:21 ET (18:21 GMT)

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