SPX Options Market Not Certain on Election Results

The stock market is showing signs of concern on the outcome of the U.S. presidential election with volatility in the options market.

The pre-election and post-election expirations demonstrate the uncertainty and SPX options, which expire after November 8 are at a premium to SPX options that expire before election day, said Russell Rhoads, director of education at the CBOE Options Institute, a Chicago-based educational arm of the Chicago Board Options Exchange. Rumors that the market is not concerned with the results of the election or that the "stock market is discounting a victory by Hillary Clinton," are not true.

These rumors do not hold up, because if the market was viewing the election results as a non-event then there would be minimal difference between the implied volatility of options expiring just before and just after the election, he said.

"In fact, I was surprised that the volatility doesn't drop more after the election results are expected to be known," Rhoads said. "Having SPX options expiring just before and after the election gives us some great insight into how much risk the stock market sees with respect to the outcome of the election."

The financial markets are generally efficient in pricing in risk, said K.C. Ma, a CFA and director of the Roland George investments program at Stetson University in Deland, Fla. Volatility usually rises when there is pending news such as the Federal Reserve announcing a potential interest rate change or company earnings releases.

The volatility or VIX is around 10 for the options expired immediately before the election date versus 12 for the options expired after the election date, he said. That's both surprising and intriguing, Ma said.

"Based on conventional wisdom, the VIX should drop after the election date because the election result is known and the risk is eliminated," Ma added.

One explanation is that although the risk of the election will be over, another factor which is cause for concern are Donald Trump's statements about not accepting the result.

"This known, non-acceptance risk will drive up the volatility into the future," he said.

Another possibility is that the post-election uncertainty arises because the public does not know how Donald Trump will deal with a defeat.

"Either way, it appears that options market rationally priced in either 'the non-acceptance risk' or 'uncertainty of suspense' in the post-election period," Ma said.

The amount of volatility is similar to what is seen in single stock options and how they behave around an earnings announcement, Rhoads said.

The options market is pricing in the possibility of a surprise, although polls and "political pundits are convinced that the election results are essentially known," said Ron McCoy, a portfolio manager on Covestor, the online investing company, and founder of Freedom Capital Advisors in Winter Garden, Fla.

Investors should be watching the spread between the pre- and post-election option volatility, because if it widens, then the "market is more concerned a surprise could ensue," he said. "Alternatively if the spread tightens, the market is signaling that the big money believes that the race is for all intents and purposes over."

The November 9 implied volatilities are "higher across the board with the difference even widening out as we move farther out of the money on the downside," Rhoads said. "We may all 'know' how the election is going to turn out, but the option market is still pricing in a little unknown post November 8."

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