Volatility Traders Pounce on Stock Market Angst Before Election

(Bloomberg) -- U.S. stock prices teetering at record highs in the grip of the presidential election cycle are sounding alarms across volatility markets for the months ahead.

Yet a slew of options traders are betting that tranquility will take hold as they seek to capture premiums that are among the richest in two decades. S&P 500 and Russell 2000 Index options that expire one to four weeks from now have seen robust selling, according to Credit Suisse Group AG strategist Mandy Xu.

These Wall Street speculators are betting continued economic policy support will ensure stock swings stay muted as a spirited bull market has the S&P 500 trading in a tight range. The benchmark hasn’t closed up or down by more than 2% since June.

The trade hinges on a historic gap that’s opened up in the volatility market between subdued actual swings of late and worrisome expectations for the future.

On the latter, there’s a lot of demand for protective options and it’s pushing up the price of the derivatives. For speculators, therefore, there’s money to be made if conditions stay calm in the near term.

“Volatility bulls and market bears have to bear in mind one overarching factor. The Fed will backstop the market by suppressing rates,” said Michael Purves, chief executive officer at Tallbacken Capital Advisors LLC. “They can continue to act with shock and awe.”

Purves clocks the gap between the Cboe Volatility Index and 30-day realized volatility in the top 2% of all readings going back to 2003.

The simple reason is that November’s presidential contest is sparking unusual levels of anxiety. Given the unpredictability of President Donald Trump, it’s no wonder VIX contacts that cover the election are sharply elevated.

October VIX futures, which encompass the election, are trading 7 points higher than the spot index, setting up a prime opportunity for rolldown trade, according to Stuart Kaiser, a derivatives strategist at UBS Group AG. The trade involves selling futures with the expectation that prices will decline as they near expiration.

What’s more, there’s been a solid trend in place for months now that realized volatility has been below expectations for the future. That gives options sellers courage to bet that markets will prove more tranquil than others expect.

Realized volatility has fallen back below levels since before the Covid crash, while the VIX has remained high. The index, a measure of one-month implied volatility, is three points above its long-term average.

To some, an elevated VIX is a warning of a crowded risk calendar –- but to options sellers, it’s another money-making opportunity.

“We still think there is a good chance that this may be one more opportunity to sell implied volatility on a tactical, short term basis,” Purves wrote in a note.

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