Traders have bet on higher volatility ahead of the election. With the odds of a contested result lasting weeks (or months), it's a good idea.
With less than two months to go until election day, money managers and traders are starting to brace for volatility. The past few weeks have raised the haunting specter of a contested election. But nearly any election outcome could lead to some big market swings.
The 2016 election saw a winner in the electoral college who didn’t win the popular vote. That’s a scenario that could occur again, particularly as the most likely path for President Trump to win reelection. As some analysts have pointed out, a candidate could win just 23% of the vote, but by targeting the right states and districts, win the election via the electoral college.
There’s also a scenario where there’s an electoral college tie. A few paths could lead to that. The Constitution gives the House of Representatives the right to declare a victory there, as it has done in the 1800 and 1876 elections (they also decided the 1824 elections between four parties where none had a majority).
While that may be upsetting to supporters of the losing candidate, the real fear is a contested election.
No matter who wins on election night, it’s possible that the losing party may follow advice not to concede. Court cases could be filed all over the country, from the district and state level up to the Supreme Court, in a more intense version of the 2000 election.
Add in the rise in mail-in ballots this year, and it’s possible that swing states could be called well before all the votes are counted, which could impact the fortunes of either candidate. Naturally, each major party thinks the other will take advantage of the situation.
What’s the stock market to make of all this? Uncertainty. That means the big swings of the past week may be just the beginning.
The stock market is good at pricing information quickly. That can include things like a company’s new product announcement.
But for the election, the winner of the White House and Senate can set major policy initiatives that can change the current “rules of the game” like tax rates and regulations. That’s why markets can move around elections, and why the warning has already been sounded.
For investors, the most significant move has come in watching the CBOE Volatility Index, or VIX. Traders have pushed up premiums on the October VIX, expecting the traditional pre-election night “October surprise.”
The CBOE Index, which historically trades around 17-20, got into the low teens at the start of the year before exploding to the 80s, beating its prior peak from the Great Recession. The VIX is currently around 28, an elevated level to historic levels, and quite high considering the market rally of the past few months.
But that surprise could last longer. If the 2000 contested election is any indication, it could be weeks. It’s no wonder that traders are pricing in a VIX over 30 by mid-October. That doesn’t mean another market crash, but it does mean that market swings of 2-3% per day are likely to increase, not decrease.
With retail traders pushing stocks back to all-time highs over the past few months, and with retail traders often being the last to know about market trends, diving in at the end, traders would be prudent to start pricing in some election-day uncertainty now, to take advantage of lower prices later.
Disclaimer: This article represents the author’s opinion and should not be considered investment or trading advice from CCN.com. Unless otherwise noted, the author has no position in any of the securities mentioned.
Last modified: September 23, 2020 2:31 PM