As a Clinton vs Trump battle looms, US markets finally begin to get the White House race jitters
Slowly but surely, the White House race is starting to influence the price investors pay to protect their equity holdings from sudden shocks.
The best illustration of this may be through measures of expected volatility in options tied to the S&P 500 Index that expire at different points throughout the year. While a broad upward slope is normal in a market where anxiety about the future gets worse with time, price jumps are now noticeable around the time of the Republican National Convention in July and the US November election.
While it's almost impossible to ascribe changes in options prices to a single catalyst, strategists see increasing evidence the presidential race is a factor.
As Hillary Clinton and Donald Trump look like they are heading for a showdown, it will only get more expensive for investors to protect their portfolios from damaging swings that can come without warning as the campaign rhetoric heats up.
"We're heading into political conventions that most people will admit are pretty scary events," said Tom Mangan, senior vice president of James Investment Research in Xenia, Ohio. "While most people have decided which side they'll come down on, the support is very tepid. The potential is there for big surprises and, of course, markets don't like surprises."
Between the Federal Reserve, China, the evolving outlook for global growth and plunging earnings, so many bombs have been falling on the US stock market that strategists have been reluctant to assign any impact to politics - so far. The S&P 500 has separately plunged 11pc and rallied 14pc in 2016, both during stretches when Clinton and Trump were effectively locking up their nominations.
Trump has secured enough votes to lock up his party's nomination, and his candidacy is upending the normally reliable Wall Street predilection for Republican administrations.
Without a clear thesis into what's good or bad, traders are making use of the options market, where you needn't speculate on the direction of a shock, just that it will happen. The cost of equity market insurance is expressed in implied volatility, the key variable in price that shows where demand is clustering at points in the future.
"More and more people are buying options targeting expiries tied to specific events and trading around them," said Stephen Solaka, managing partner of Belmont Capital Group in La. "They're either hedging or making directional bets, and that's why you see kinks in the curve. It's a fairly common tactic, and it's getting more popular."
Nothing that affects equity prices happens in isolation, and one trader's anxiety over politics mingles with another's about economic growth. Take the bump in volatility expectations that occurs from July 22 to 29 on the S&P curve. It coincides with the Republican National Convention on the four days ending July 21, but also with a Fed policy announcement scheduled for July 27. Either way, there's strong evidence something is bugging options traders around those dates.
After spiking up, volatility expectations quickly calm down in the weeks after, a classic sign of event risk to BNP Paribas. "At that point, the general electorate and investors will have a much better sense how successful Donald Trump might be," said Anand Omprakash, an equity-derivatives strategist at the firm. The slope of expected price swings starts higher again at the end of July and continues rising through the end of September, a period that includes the September 21 FOMC decision. For September 16 to 30, S&P 500 options are embedding a price swing that's 1.5 percentage points above the historical median.
Implied volatility falls the following week, a move that's anomalous to a curve that should rise with every subsequent data point. The expected volatility is calculated using forward S&P 500 options with an exercise price of 2,075.
The rising curve also captures the premium being paid prior to the presidential election. For an event of that magnitude, it's not uncommon for investors to start positioning in the preceding months. (Bloomberg)