Options Traders Brace for Volatility as US Election Looms
Just before a highly contested US election projected as a toss-up, options traders across various markets are exhibiting signs of risk reduction and preparing for potential volatility surges.
Equity options volatility has steadily climbed throughout October, even as the market’s swings have remained muted. Traders anticipate not only the upcoming election but also earnings season and a Federal Reserve interest-rate decision. With the race between Kamala Harris and Donald Trump remaining too close to call, uncertainty hangs heavy.
Bond Yields on the Rise
Bond yields have been trending upwards since the Fed’s rate cut in September, prompting some investors to scale back futures positions and implement hedges against potential higher rates.
Currency Markets Grapple with Uncertainty
In the currency market, traders are primarily positioning for wider swings. Volatility for the yuan, Mexican peso, and euro has increased due to concerns regarding trade and tariffs.
“Positioning is pretty clean after some general de-risking the past few weeks into the election and Fed meeting,” noted Stuart Kaiser, a US equity trading strategist at Citigroup Global Markets Inc. “That is good for risk/reward post election depending on result of course. Bonds seem to be moving more than stocks.”
Options Strategies Across Asset Classes
Stocks
Short-term options are dominating election-related hedging strategies, as they allow for easier positioning closer to the event. Implied volatility is exceeding realized levels, with investors bracing for broader swings even as the S&P 500 Index went 29 sessions without a drop exceeding 1%.
“We continue to see an interest in trades around the election with a pick up in recent days,” said Daniel Kirsch, head of options at Piper Sandler & Co. “Clients who expect Donald Trump to win the election are adding exposure to financials and crypto stocks, those who are betting on a Harris win buy options on renewable-energy stocks. There’s also a pickup in hedging with traders piling into put options for the S&P 500 and QQQ ETF.”
Short-term S&P 500 implied volatility has outpaced one-month levels, reflecting the impact of the election and Fed uncertainty on calculations. The Cboe VVIX Index — which gauges the volatility of the VIX — is also elevated.
“Currently, the options skew is steep and VIX is much higher than realized volatility,” observed Zhiwei Ren, portfolio manager at Penn Mutual Asset Management. “These are signs that the market is well hedged at this point.”
Despite elevated volatility, current indications suggest a potential 1.7% move for the S&P 500 on the day following the election, a swing not considered excessively drastic. Implied movements have steadily declined from a peak of around 2% in early October to align with the long-term average for past elections, according to Stefano Pascale, head of US equity-derivatives strategy at Barclays Plc.
Beyond broad indexes, sectors like crypto and clean energy stocks are experiencing increased volatility that significantly surpasses their historical medians. Crypto stocks are pricing in potential 10% moves, Morgan Stanley’s trading desk reported last week, while those for renewable firms stand around 6%. This trend is evident in trading activity, with over 20,000 November call spreads being purchased last week in Sunrun Inc.
Steady post-election fundamental market flows are anticipated to support an upward rally toward the end of the year, fueled by the removal of hedges, increased mutual fund buying in November, company stock buybacks, and lower volatility attracting systemic buying and re-hedging by options dealers.
“Assuming a smooth post-election period, we believe these hedges may unwind and we could see a sharp drop of VIX and flatter skew,” said Ren. “If both happen, it could force more buyers into the market and push the market higher.”
FX
Short-term currency options are now reflecting the weight of election-related risk and predicting wider swings in the aftermath of the US vote. One-week dollar-yuan swings reached a record high late last week as traders hedged against the possibility of escalated US tariffs, as well as a global trade war that could disproportionately impact China.
Volatility in the euro — also vulnerable to potential tariff consequences of a Trump victory — has risen to its highest level since March 2023, representing the most significant increase since 2020. Risk reversals remain bearish on the euro compared to the US dollar. One-week volatility on the peso has climbed to its highest point in over four years, and its premium compared to expected swings further out in time has widened to the most since Bloomberg began compiling data in 2007.
Rates
Positioning in the Treasuries market over the past few weeks has centered around traders reducing leverage in futures, reflecting a skewed preference for long liquidation amid rising expectations of post-election fiscal stimulus, which could lead to an increased Treasury supply. This result has been reflected in open interest, or the number of positions held by traders, declining sharply in 10-year note futures since the start of October as yields have climbed.
The de-risking trend has also been observed in the cash market, where JPMorgan Chase & Co.’s latest survey indicates clients are reducing both long and short positions, while neutral positions are rising. Within the Treasury options market, tail-risk hedges focus on higher yields and a larger bond market selloff compared to current levels.
“Election volatility premium is most pronounced in the bond market on long-end rates, which we believe reflects concerns over higher fiscal risks on a sweep outcome,” said Tanvir Sandhu, Bloomberg Intelligence’s chief global derivatives strategist. “The skew suggests demand for hedges using payer swaptions against a selloff in long-end rates.”
Crypto
Crypto traders are exhibiting divergent viewpoints regarding the election outcome, with the options market shifting from an aggressive bullish stance to a more hedging-focused approach. Implied volatility for short-term contracts, such as 14-day puts, has climbed significantly while calls with the same expiration dates remain stable, according to data compiled by crypto liquidity provider B2C2.
While there is no clear directional bias with heightened volatility leading into the election, increasing premiums for longer-dated calls and BTC futures on CME point to a bullish outlook beyond the election, anticipating potentially further rate cuts and favorable crypto policy changes in the coming year.
Cross-Asset
Binary options — where a payout is triggered if a pair of conditions are fulfilled, such as a currency and a stock reaching pre-determined levels — are a commonly used tool to hedge against potential outcomes during major events. Trading activity in these options has increased leading up to the election, according to Esmail Afsah, a derivatives strategist at JPMorgan.
“I suspect this is mainly because investors have firm views on how individual assets are likely to behave in the four key permutations of the US election,” Afsah said. “Using hybrid options and betting on the direction of two assets concurrently allows to increase leverage materially and thus improve odds, providing of course that assets do indeed behave as expected.”