The Relationship Between Elections and Volatility
By Scott Bauer
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Specifically, the three months leading up to a presidential election and the week or two post-election have experienced above average volatility. By a month or so following an election, volatility has typically normalized, likely because the uncertainty of the election results is no longer present.

Gold CVOL

Trading Volatility with Equity Options

Traders can take a position on volatility in the equity space by buying volatility or buying options a few months in advance of the election. This can be done with no directional market bias by purchasing both a call and a put option in the E-mini S&P 500 or E-mini Nasdaq-100. 

The risk to this type of position, known as a straddle (same option strike) or strangle (different option strikes, typically both out of the money), is that as time progresses, the value of these options could decrease if volatility doesn’t increase. If volatility stays flat or decreases, one methodology that I personally have used is to sell the same strike options that have an earlier expiration date. This allows the opportunity to “roll out” the short options to sell other ones against the purchased ones. This type of strategy is called a “calendar/diagonal” or “time spread.”

The value to this type of position is that since the longer dated options have more volatility sensitivity (known as vega) than the shorter ones, as volatility potentially increases the value of the position also increases. Many traders feel safe moving to cash until after the election but attempting to time the market can lead to missed opportunities. Buying volatility can provide a different alternative to some traders who choose to move to defensive assets like cash, because they are still invested in the market but can potentially profit off the uncertainty and sharp movements that may occur. 

While markets are typically influenced more by inflation, interest rates and geopolitical uncertainty, there are still opportunities for traders to take a view on volatility leading up to the election.

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About the author

Scott Bauer
Scott Bauer, CEO, Prosper Trading Company

Scott Bauer graduated with honors from the University of Illinois Business School, Urbana Champaign, in 1988 with a B.S. in Finance. Bauer began floor trading in 1991 and formed BOTTA Capital Management in 1995. Scott traded equity options, S&P options at CME and was employed by Goldman, Sachs & Co. as Vice-President, Equities Division. He is currently CEO of Prosper Trading Academy and appears regularly on CNBC, Bloomberg Financial and Fox Business as a guest commentator.

 

 

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