If the polls are wrong you want to be hedged: Wall Street votes
Traders may want to think about taking out some insurance, just in case the polls are wrong again.
Global financial markets are increasingly pricing in the idea that Democratic challenger Joe Biden will not only unseat President Donald Trump at next month’s U.S. election, but that he will have a friendly Congress as well.
U.S. stocks and Treasury yields have risen on the prospect that a Biden administration will usher in a bigger fiscal stimulus, while the dollar has fallen and measures of implied market turbulence – aided in part by the support of the U.S. central bank – have been subdued. Yet while opinion polls both nationally and in critical swing states have Biden leading, the memory of 2016’s shock presidential election result stands as a warning.
Volatility markets “may have gotten a bit too complacent,” according to Ladislav Jankovic, global foreign-exchange derivatives strategist at JPMorgan Chase & Co. That backdrop, combined with favorable volatility pricing “make it prudent to put on cheap election hedges,” he said.
The word cheap is key. While there is a possibility that Trump will win, the most likely outcome – at least based on polls – is that he will lose, and investors may therefore be reluctant to pay too much of a premium to guard against a so-called tail risk.
With that in mind, Jankovic and his colleagues recommend option bets that stand to benefit from gains in the U.S. dollar.
A win by Biden is seen by many observers as being more negative for the dollar, fueled in part by expectations that he would deliver a bigger fiscal stimulus package and that the resulting debt may weigh on the currency. It could also help boost investor risk sentiment and sap appetite for havens like the dollar. An upset win by Trump, on the other hand, could help buoy the greenback.
According to JPMorgan, option strategies based on dollar calls – the right to buy greenbacks at a particular price – generally performed better in the wake of Hillary Clinton’s surprise 2016 loss than other “risk-off constructs,” such as those involving either euro or yen calls.
This time around, they say that using options to bet that the dollar will climb against its Australian counterpart looks the best, while similar wagers on a declining offshore yuan are also worth considering. That’s because the Aussie’s spot price doesn’t have to move as much as its peers to trigger the option, while the renminbi has been in focus amid China’s trade spat with the U.S.
More specifically, they recommend funding these positions with a dollar/rupee option structure so as to create a “near zero” cost for the trade. The rupee is not expected to react as much around the election event. The options strategy carries a two-month tenor to capture the risk into and after the election.
“Wall Street Votes” is a column highlighting opportunities for investors deluged with political news.