From U.S. stocks to cryptocurrencies, let's see how investors are preparing for the U.S. elections?

This article is sourced from: Jin Shi Data

As the fiercely competitive U.S. election is seen as too close to call, options traders in the market seem to be reducing risk and preparing for more volatility.

For most of October, the volatility of stock options has been rising, even though the market's fluctuations have not been significant, as people are not only anticipating the upcoming election but also looking forward to the earnings season and the Federal Reserve's interest rate decisions. The election situation between Harris and Trump remains undecided at the last moment.

Since the Federal Reserve cut interest rates in September, bond yields have been rising, leading investors to pull back some futures positions and increase hedging against tail risks from rising interest rates.

In most cases, currency traders are betting on greater volatility, with fluctuations in the renminbi, Mexican peso, and euro exacerbated by uncertainties surrounding trade and tariffs.

Stuart Kaiser, U.S. equity trading strategist at Citigroup's Global Markets, said that many people have been reducing risk in the past few weeks as the U.S. election and Federal Reserve meeting approach, "positions have become quite clean," which is favorable for post-election risk/reward, of course depending on the outcome. "Bond volatility seems to be greater than stock volatility."

Now let's take a look at how options traders are pricing across various asset classes from stocks to cryptocurrencies:

U.S. Stocks

As expected, most of the hedging related to the election has emerged at the last minute, as short-term options are easier to hedge as events approach.

Implied volatility is far higher than actual levels, even though the S&P 500 Index has not seen a decline of more than 1% for 29 consecutive trading days, investors are still preparing for greater volatility.

Daniel Kirsch, head of options at Piper Sandler & Co., said, "We continue to see trading interest around the election, which has picked up in recent days . Clients expecting Trump to win the election are increasing their positions in financial stocks and cryptocurrency stocks, while clients betting on Harris's victory are buying options in renewable energy stocks."

Hedging trades are also increasing, with traders buying put options on the S&P 500 Index and QQQ ETF.

As the impacts of the election and the Federal Reserve permeate the calculations of short-term indicators, the short-term implied volatility of the S&P 500 Index has remained high relative to the one-month level. The Cboe VVIX index, which measures VIX volatility, has also risen.

"Currently, the options skew is steep, with VIX far above realized volatility," said Zhiwei Ren, portfolio manager at Penn Mutual Asset Management. "These signs indicate that the market is well-hedged at the moment."

Although volatility has increased, the expected volatility of the S&P 500 Index on the day after the election is about 1.7%, which is not significant.

Stefano Pascale, head of U.S. equity derivatives strategy at Barclays, stated that implied volatility has steadily declined from a peak of about 2% in early October, roughly in line with the long-term average of previous elections In addition to general indices, the volatility of certain sectors such as cryptocurrencies and clean energy stocks is also soaring, far exceeding the median. Morgan Stanley's trading department stated last week that the volatility of cryptocurrency stocks is close to 10%, while the volatility of renewable energy company stocks is about 6%.

Once the election is over, the fundamental market liquidity will support a year-end rebound, as hedges will be unwound, mutual funds will start buying in November, companies will repurchase stocks, and reduced volatility will attract systematic buying and re-hedging from options traders.

“Assuming a smooth period after the election, we believe these hedges may be lifted, and we could see the VIX index drop sharply, with a flatter skew,” Ren said. “If both of these scenarios occur, it may force more buyers into the market, pushing prices higher.”

Forex

Due to expectations of greater volatility following the U.S. election voting, the implied volatility of short-term currency options that have priced in election risks has surged.

Last weekend, the weekly volatility of the U.S. dollar against the Chinese yuan hit a historical high, as traders hedged against the possibility of Trump threatening to raise tariffs in the U.S. and a potential global trade war.

The volatility of the euro saw its largest increase since 2020, reaching its highest level since March 2023, while the risk reversal of the euro against the U.S. dollar remains bearish.

The weekly volatility of the Mexican peso has climbed to its highest point in over four years, with the premium for expected volatility also expanding to the highest level since Bloomberg began compiling data in 2007.

U.S. Treasuries

In recent weeks, positions in the U.S. Treasury market have primarily focused on traders deleveraging their futures positions, leaning towards long liquidation, as expectations for fiscal stimulus policies post-election have been heating up, which would increase the supply of Treasuries. As a result, since early October, the number of open contracts (i.e., the number of positions held by traders) for 10-year Treasury futures has significantly decreased as yields have risen.

J.P. Morgan's latest survey shows that as neutral positions increase, clients are reducing both long and short positions.

In the U.S. Treasury options market, the goal of tail risk hedging is higher yields and a larger bond market sell-off compared to current levels.

The price of the 109.50 December 10-year Treasury put options is significantly elevated, equivalent to about a 4.5% yield, which is about 25 basis points higher than current levels.

Tanvir Sandhu, Chief Global Derivatives Strategist at Bloomberg Intelligence, stated: “The election volatility premium is most evident in the long-end rates of the bond market, which we believe reflects market concerns about higher fiscal risks resulting from the election outcome. This slope indicates a demand for hedging using payer swaps in the event of a long-end Treasury sell-off.”

Cryptocurrency

Cryptocurrency traders have differing views on the election outcome, with the options market shifting from a bullish outlook to a greater focus on hedging.

According to data compiled by cryptocurrency liquidity provider B2C2, the implied volatility of short-term contracts such as 14-day put options has surged, while the implied volatility of call options with the same expiration date has remained stable Although the volatility before the election has no obvious directional tendency, the increase in the premiums of long-term and expiration Bitcoin call options on the CME indicates a bullish outlook after the election, with more potential interest rate cuts and positive changes in cryptocurrency policy expected next year