Expected Volatility in the months ahead

Tom Boyle
06-10-2020

To start the week this week we asked one of the derivative geeks, sorry gurus, Tom Boyle who we work closely with at Atlantic House Investments to talk us through what the market is telling us about the level of volatility and risk the market is anticipating around the time of the US election.

“The diagnosis of President Trump exacerbated an already widening gap between the President and his democratic rival, Joe Biden. The Presidential debate at the end of September confirmed the polarisation that has torn the two US parties apart during a period in which, one would hope, party politics would be set aside.

Trump is not the only world leader to have contracted COVID-19. Both the UK Prime Minister and the Brazilian President both contracted the virus. However, Trump is the only leader to be facing re-election immediately. This is likely the hardest challenge which the Trump campaign has been presented with. A certain amount of Trump brand rhetoric of ‘Fake News’ can cover overcome a wide range of hurdles. You cannot simply push aside a serious illness. Shortly after the President tweeted that he and the First Lady had tested positive US index futures fell 1.8%.

There are two possible results from Trump’s diagnosis. If he has mild symptoms and is discharged early, as his doctors have suggested, then his strategy of restarting the economy is likely to be vindicated in many voters’ eyes. If his health deteriorates then many swing voters will view the democrats approach as more responsible than Trump who has repeatedly refused to wear a face covering.

Although the recent diagnosis increases the chances of Biden winning the election, we believe that anything except a Trump sweep will result in some sort of contested election. Both sides of the campaign have stepped up their views around a contested election. The Republicans view postal voting as a huge opportunity for electoral fraud, whilst the Democrats view voter ID laws in many states to be in breach several constitutional amendments, specifically the Fifteenth, Nineteenth and Twenty Sixth. Either way this election is likely to have more of an ‘event’ for markets than the last given the polarizing nature of the candidates on a range of issues.

If we look at the derivative markets, we find a similar story. Expectations of daily moves in the S&P for this election are almost twice what they were at the same time before the 2016 election.

Source: Bloomberg, Atlantic House

The difference with 2020 is that volatility is higher and is expected to stay higher following the day of the election itself. This shift towards ‘higher for longer’ has only surfaced in the last two weeks. We can see this in the VIX futures curve (the expectation of volatility across different month for the S&P 500). Since the beginning of the year, the future refencing volatility for November (the month of the election) has been the highest, with a distinct ‘kink’ around the event itself. Moving forward to today, that same ‘kink’ now points towards December being the most volatile. Indicating other investors agree with our thesis that the election will not be over and done with on November 4th.

The derivative market does not just tell us what expectations are for the S&P 500. There are a range of different assets which have active derivative markets. The price of Gold is expected to move the most since the 2008 election (+/- 2.5% on the day of the election, vs -3.5% in 2008).”