For reasons well known by investors, 2020 has seen an explosion in realized and expected stock-market volatility. Don’t expect that to change once the election is over.
The Cboe Volatility Index, or VIX (VIX)—a measure of market volatility calculated from pricing of S&P 500 (.SPX) options for the next month—has remained in the high 20s even as the market has steadily rebounded from its tumultuous selloff in February and March.
The VIX hit a post-financial crisis high of 82.7 on March 16, after spending most of the past decade in the teens with only brief spikes above 20. It closed at more than 29 on Wednesday. That implies daily moves of about 1.8% for the S&P 500 over the coming month.
And traders and options buyers see volatility picking up in the remainder of 2020. The November U.S. election, a potential fall resurgence in Covid-19 cases, a successful vaccine trial—numerous events could swing the market higher or lower, and uncertainty remains high. Futures markets are currently pricing a VIX at 32.4 in October, 33.4 in November, and 31.9 in December.
That’s an evolution in the VIX curve from its shape earlier this year and in prior election years, when futures were highest for October and declined in the final two months of the year. Now, traders are pricing in greater volatility in the month after the election than the one before.
“In elections past, it was easier to come to assume we would know the winner by the first few days of November,” says Matt Rowe, chief investment officer at Headwaters Volatility. “This year, the kink in the VIX curve has moved from October to November. The preponderance of mail-in ballots and the strategy of confusion around election integrity, particularly from the incumbent, gives reason to believe this election is not going to be done and celebrated within a couple of days.”
That has implications for the stalled fiscal stimulus legislation in the near term, and other policy in the long term. In contrast with the bipartisan sense of urgency to get support passed in March, the next coronavirus relief bill has turned into an election issue, with compromise hard to find in Washington. Federal Reserve chair Jerome Powell and economists have pointed to the need for further stimulus to keep the U.S. economic recovery going and unemployment falling. That in turn has implications for corporate earnings and stock valuations.
A period of uncertainty in the weeks after the election around the winner and the impact on fiscal policy implies a wide potential distribution of levels for the S&P 500—more or less what the VIX measures.
“A VIX at 29, historically speaking, is pretty high,” says Rowe. “For where we sit right now, it seems about right.”
Rowe recommends hedging stock-market exposure with assets like long-dated U.S. Treasuries, such as through the iShares 20+ Year Treasury Bond ETF (TLT). Investment-grade corporate bonds could also benefit in a flight-to-quality trade while offering a higher yield than government debt. One ETF there is the Vanguard Long-Term Corporate Bond Index Fund (VCLT).
Buying protective puts on the S&P 500 expiring in November or December could also provide a safety net if the market hits a rough patch around the election. But investors should be careful about position sizing—don’t bet the farm on any option.
“Just don’t go into this with unprotected equity exposure because it might not go well for you,” Rowe says.
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