As we careen toward a U.S. presidential election unlike anything we have ever experienced in modern America, investors should consider insulating their investment portfolios from bizarre political shocks.
Portfolio hedging is something we rarely endorse because most investors are terrible at it, and the market generally prices downside put options with such intense fear premiums that most people stand a better chance of winning the lottery. Because of those dynamics, we have long advocated selling cash-secured puts to potentially buy admired stocks at lower prices, a strategy that monetizes the fact that puts are mostly overpriced most of the time.
But we are making an exception to our usual antihedging approach in that we are in a historically strange time.
Serious people are seriously discussing that the results of the presidential election could be contested, and that the most powerful office in the world may not pass peacefully for the first time in U.S. history.
Of course, it is too hard to know at this point if President Donald Trump will win a second term, or if his challenger, Joe Biden, will triumph. But many people are deeply angry and afraid that their way of life is in danger. Those feelings are so rampant that it is easy to imagine that our enemies are laughing at us and delighting in our troubles.
Trump has warned that election results may not be known for weeks, or longer, if people cast ballots via the mail. He insists that he is “the only thing standing between the American dream and total anarchy, madness, and chaos.” Some will agree, and others will dismiss his rodomontade, noting that everything he is warning about is now occurring under his watch.
The Covid-19 pandemic continues to ravage our economy. Millions of Americans are unemployed. People are fleeing major metropolitan cities that have long been international capitals of commerce and innovation.
Gun sales are at historic highs, and it is hard to find ammunition. Heavily armed protesters are descending on cities. Some have shot and killed one another.
Yet the S&P 500 index behaves like the financial version of Chief Broom from the movie One Flew Over the Cuckoo’s Nest. The main barometer of U.S. stocks is medicated with low interest rates and is seemingly unaware of anything that is happening. Tyros with small accounts at discount brokerages are trading stocks, including Apple (ticker: AAPL) and Tesla (TSLA), and easily making money off the momentum.
It is precisely because nothing seems capable of interfering with the equity market’s advance that hedging portfolios is worth considering.
To offset a decline of about 10% around the presidential election, investors could buy three S&P 500 November $3,500 puts for $42,900 to hedge a $1 million portfolio. (Puts give buyers the right to sell an asset at a specified price and time.)
If the S&P 500, currently at 3581, declines to 3200 at expiration, the put value is worth $90,000, creating a $48,000 profit on the hedge. If the index is above the put strike price at expiration, the trade fails.
The November expiration covers the Nov. 3 presidential election and any strangeness occurring in the immediate aftermath.
“The options market is pricing this election like it will be one for the history books,” says Michael Schwartz, Oppenheimer & Co.’s chief options strategist.
The options market is Wall Street’s great probability lab, and it views the election as 2020’s most volatile moment. The Cboe Volatility Index, or VIX, futures curve—which largely dictates VIX options prices—is sharply elevated ahead of the election. It smartly declines afterward.
The VIX market shows that institutional investors think that Trump versus Biden will be an insanely erratic event in an erratic year that has broken the health, hearts, and wealth of many. Investors can profit from that.
Email: editors@barrons.com
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September 03, 2020 at 06:00PM
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This Election Could Be Really Weird. Hedge Your Portfolio. - Barron's
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