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Traders wake up to hedging as election jitters jolt stocks

[November 02, 2016] By Saqib Iqbal Ahmed

NEW YORK (Reuters) - With a week to go to the U.S. presidential election and some polls showing a tightening race, political risk is suddenly back on the radar, and equity options traders are positioning to deal with any stock market mayhem should it arise.

Until this week, most polls showed Democrat Hillary Clinton with a comfortable lead over Republican Donald Trump. A Reuters equity market poll last month showed a majority of forecasters predicted that U.S. stocks would perform better under a Clinton presidency than a Trump administration.

Presumptions of an easy Clinton victory have been upended in the last several days after the FBI said it was probing newly found emails related to Clinton's use of a private server, and that has begun to roil equity markets.

This week traders have started to load up on contracts such as CBOE Volatility Index call options in a bid to profit from increased stock gyrations. As of Tuesday, open VIX call contracts outnumbered puts by a 3.5-to-1 margin, the most in about six months, according to options analytics firm Trade Alert data.

Positioning in contracts that expire in November is even more defensive with more than four VIX calls open for each open put contract.

"The VIX has gone up for six straight days, so that right there tells you that people are bidding up the prices of the options on the S&P 500," said Randy Frederick, managing director, trading and derivatives, at Charles Schwab in Austin, Texas.

Frederick also pointed to unusually strong trading volume for options on the VIX and the S&P 500's tracking exchange-traded fund <SPY.P> as a sign of increased demand for hedging.

SPY options trading volume jumped to 3.8 million contracts on Tuesday, or 1.5 times the daily average volume, according to Trade Alert.

Traders have also shown a preference for options contracts that expire closest to the election, as these are likely to be the most sensitive to the results.

For SPX options expiring a day after the Nov. 8 election, implied volatility - a gauge of the risk of large moves in the index - is at 22.2 percent, the highest for any listed expiration, according to Trade Alert data.

S&P 500 weekly contracts that expire later that week on Nov. 11 have call contracts outnumbering puts 2-to-1, according to Thomson Reuters data. That shows a slightly more defensive stance than for all SPX options contracts expiring after that date.

The cost of an SPX straddle, a strategy in which a trader buys an at-the-money put option and a similar call option, implies a move of about 2.4 percent in either direction by Wednesday.

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Traders work on the floor of the New York Stock Exchange (NYSE) in New York City, U.S., October 24, 2016. REUTERS/Brendan McDermid

Hedging activity has picked up noticeably over the last week. Until recently there were few signs of traders hunkering down for big stock market gyrations around the election.

While some of the pickup may simply be due to the growing proximity of Election Day, some is likely linked to the uncertainty spurred by the FBI news late last week, Frederick said.

Clinton held a 5 percentage-point lead over Trump, according to a Reuters/Ipsos opinion poll released on Monday, little changed since the FBI announcement.

But other polls showed a Trump surge. A poll by ABC News showed the Republican leading by 1 point and the Los Angeles Times put Trump more than 2 points ahead.

On Tuesday, Wall Street sold off sharply with the S&P 500 closing at a near four-month low, amid growing concern over next week's election.

The CBOE Volatility Index, an options-based gauge of near-term investor anxiety, spiked above its long-term average of 20 to hit a seven-week high.

The spike in volatility is in sharp contrast to the record level of calm in the market in recent weeks.

For October, the S&P 500 Index's realized volatility - a measure of how much the stocks have actually moved - was at 6.6, the lowest for an October in 23 years, according to an analysis by derivatives analysts at Goldman Sachs.

(Reporting by Saqib Iqbal Ahmed; Editing by Dan Burns and Leslie Adler)

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