Put Options and the Presidential Election
I’ve received several Presidential Election questions recently.
A typical question might be “Does a (Trump or Clinton) win pose significant potential damage to the market?” or “What is the best way to hedge if (one or the other candidate) wins?”
I won’t give you my political views—you don’t care and I’m not sharing—but I will share the view of the Presidential Election through a trader’s perspective.
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Most traders don’t believe a Trump or Clinton victory matters to the market. What does matter is uncertainty.
A good example was the George W. Bush vs. Al Gore election in 2000. It was a calamity for the markets because the election was too close to call for months.
So I don’t anticipate significant volatility if Clinton or Trump runs away with the election. But if the race really tightens up, there is certainly the potential for short-term volatility—because the market hates uncertainty!
While the media says the race is close, the betting houses’ odds have Clinton as an approximate 65/35 favorite—probably a comfortable enough lead for the markets. (That said, bear in mind that the same betting houses got Brexit wrong!)
If you are the least bit concerned about the election outcome and want to hedge your portfolio, the price of puts/protection is surprisingly cheap.
Put Protection Surprisingly Cheap
The Chicago Board of Options Exchange Volatility Index (VIX), which is often referred to as the “fear index,” is trading at historically low levels, which means protection is inexpensive. Here is a graph of the VIX over the past year:
Knowing that the VIX is low and puts are inexpensive, let’s take a look at how you might hedge your portfolio using put options.
A put option is an option contract that gives the owner the right, but not the obligation, to sell a stock/index at a specified price within a specified time. The buy of a put is a bearish position.
For this exercise, I’ll use the SPDR S&P 500 ETF (SPY), which possibly offers the truest hedge for a typical investor with a well-balanced portfolio.
You could buy one SPY January 214 Put for $6.00. If the SPY drops below your put’s strike price (214)—because of an election shakeout, Deutsche Bank worries or any other reason—you could exercise your put, which would leave you short 100 shares of the SPY at 214, or you could sell your put for a profit.
(At Cabot Options Trader and Cabot Options Trader Pro, we rarely take delivery of the stock; instead, we typically sell out our calls/puts for a profit or loss.)
However, you do have to pay $6.00 for this put, which is actually $600, as each put equals 100 shares of stock. This $600 is the cost of insurance. But with the VIX at these low levels, this insurance is extremely cheap compared to historical prices.
The upside to this strategy is that you don’t cap the upside of the rest of your portfolio if the market continues to rise.
Buy Puts Against Any of Your Holdings
You can buy put options against any of your holdings. If you fear that your exposure to the Nasdaq will fall, you could buy the QQQ December 116 Puts for $3. And, you can choose any number of strikes and timeframes for this strategy (puts expiring at the end of November are even cheaper).
Or, if you own a lot of Boeing (BA) or General Electric (GE) stock for instance, you can hedge your stock positions with the same strategy.
The challenge to hedging a portfolio is determining how many put options you should buy. That’s a personal decision because each investor has his own risk profile. I typically recommend buying the number of puts that will allow you to sleep at night.
To receive more guidance on how to buy put options successfully and see for yourself how to profit from options trading, consider taking a trial subscription to Cabot Options Trader.
Jacob Mintz is a professional options trader and Chief Analyst of Cabot Options Trader. He uses calls, puts and covered calls to guide investors to quick profits while always controlling risk. Beginners and experts alike can gain from following Jacob’s advice.Learn More