Today is finally Election Day! The roller coaster of headlines and polls are sure to continue to cause market volatility, and whether Clinton or Trump win, sector rotation will be incredibly fierce.
The options trading market can tell us what is being predicted in terms of market movement, and how the most sophisticated hedge funds and institutions are positioning and hedging. With that in mind, here’s how to hedge the presidential election.
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First, let’s take a look at the expected move in the market between today and the end of the week. To come up with the expected move in the S&P 500 ETF (SPY), we add the at-the-money call and at-the-money put of the SPY ETF. With the SPY trading at 212, we will look at the 212 strike. Here are the values of these calls and puts:
The call value is on the left and the put value is on the right. We add those two together, and get 5.13. This means that the options market believes the SPY will potentially move 5.13, or 2.41%, by 11/11. This puts the SPY at 206.87 to the downside, and 217.13 to the upside.
This past Friday, I wrote up a much more detailed Election Day breakdown for Cabot Options Trader/Cabot Options Trader Pro subscribers that included my trade ideas, as well as which sectors the top hedge funds are targeting. Click here to subscribe to either service.
Last week, my Options Scanner began picking up on Election Day hedging. For example, with Bank of America (BAC) trading at 16.85, a trader executed the following trade:
Buyer of 50,000 Bank of America (BAC) November 16.5 Puts (expiration date 11/11/2016) for $0.20
The critical component of this trade is the expiration date of the puts purchased—Friday, November 11—just a couple of days after the election. In recent years, weekly options such as these BAC puts have been listed for many of the leading stocks in the market (Facebook, Microsoft, Amazon, etc.) These are options that expire each Friday afternoon.
While I don’t typically trade weekly options because I look on them as pure gambling, in some instances, weekly options can be great tools for a binary event. This BAC trade is a great example.
Let’s assume the trader who bought 50,000 BAC November 16.5 Puts also owns 5 million shares of BAC.
The purchase of the puts is a capital outlay of $1,000,000. However, if BAC were to drop below 16.5 on 11/11, he could exercise his right to sell those 5 million shares at 16.5. If the election is a non-event, and BAC did not drop below 16.5, he would lose the $1 million dollar insurance policy.
Now let’s compare the weekly puts vs. December 16.5 puts that were worth $0.35 the day the big trader executed his large purchase. If the big trader wanted to hedge a position of 5 million shares, he would need to buy 50,000 of these puts for $0.35, a capital outlay of $1.75 million. As you can see, by purchasing the weekly puts, he saved himself $750,000. The downside to the weekly puts is that the puts will go to zero on 11/11 if BAC is above 16.5.
Conversely, if you think that a stock or sector will break out once the election has passed, you could buy weekly calls. So if you believe the market will rally once the overhang of the election has passed, you could buy weekly SPY calls.
For example, you could buy the SPY November 212 Calls (expiring 11/11/2016) for $2.48.
The most you can lose on this trade is $248 per call purchased if the SPY were to close below 212 on 11/11.
Your breakeven on this trade is $214.48.
And for every $1 the SPY trades above 214.48, you would make $100 per call purchased.
As I wrote above, I typically don’t buy weekly options because they have the potential to lose all of their premium very fast. However, the BAC example is exactly how I would hedge a big stock position if I liked the long-term prospects of a company, but was worried about a short-term shock.
And weekly options can be a great tool to gamble on a big upside move—such as how to hedge the presidential election.