With the U.S. presidential election less than 2 weeks away, an eerie calm has taken over the markets. The CBOE Fear Gauge (the VIX index) and implied volatility for the broad market SPY ETF options have come down. The markets are not quite ready to say there will be no surprises come Election Day, but implied volatility is on the lower side. Interestingly, the same phenomenon occurred going into the British Exit (BREXIT) vote just a few months ago. Well, there was a surprise outcome from that vote, and it moved the markets rather dramatically if you recall!
Is this the calm before the storm? Or the eye of the storm between the UK vote and the US vote? I’m not saying the same thing is going to happen in the US as it did in the UK, but I find it a little ironic how quickly the markets seem to forget something that happened relatively recently.
Implied volatility, the metric that indicates how markets actually price risk, can be measured across time. There is near term volatility, medium term volatility, and longer term volatility. In fact, the market prices in expected moves in volatility in anticipation of an event, like an earnings announcement or an election. If we take a look at the volatility constellation for the S&P 500 ETF (SPY), we see that very near term volatility is priced around 12%, but it jumps to 16% the week of the election. And then we see it tail back down toward 14% by Thanksgiving.
So, although the markets don’t seem to think anything drastic is going to occur as an outcome from the election, there is indeed a bump in volatility being priced into the market the actual week of the election.
With this election cycle, there is also a lot of emotional uncertainty. It is difficult to remember an election that has such heated rhetoric, including physical confrontations.
It is times like these that force investors to take stock of their assets (pun intended). Here’s a few things all investors should be considering so that uncertain times like this hopefully won’t keep you up all night.
- A diversified portfolio. It is important to diversify the holdings in any portfolio. While many active investors translate this to mean holding stocks in different sectors of the market (which, by the way is a very good idea), it is also a good idea to be diversified across asset classes (which can include diversity in options strategies, investments in bonds and investment in futures).
- An appropriate risk profile. Different investors are at different stages of their life. Younger investors may have a longer time horizon for their investing than more mature investors. Risk tolerance is a personal choice, but it’s good to keep perspective on your own time horizons and manage risk according to when you may need to access the funds from different assets. If you are going to need the cash, it is always better to sell an asset when you want to sell it rather than when you have to sell it.
- Protection? People are very comfortable with the concept of protection when it comes to their healthcare, their automobile, or their house. Not many people are familiar with the concept of protection for their financial assets. There are indeed options strategies to specifically mitigate the risk of large, significant moves in stock prices. Buying puts is a straight up basic one, but there are other ones as well (like using stock-replacement calls instead of continuing to hold a long equity-only portfolio).
- Remain calm and stick to your plan. It is very easy to lose focus of your long term strategy with the emotional upheaval that you see and read in the press on a daily basis. If you have followed the advice from above, you should be able to sleep comfortably at night knowing that you have done the right things and that your assets, and your financial plan, are on the right road – even if there is uncertainty, or possibly a speed bump up ahead.
- And lastly, please exercise your right to vote!
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