S&P 500 Skew Unwind Shows Complacency Over Clinton Win: Analysis
The U.S. election premium is evaporating from S&P 500 options. Even as the shock Brexit result stays fresh in investors’ minds, SPX term structure is turning relatively smoother with skews declining as opinion polls show Clinton may triumph over Trump, Bloomberg strategist Tanvir Sandhu writes.
The kink that had formed in SPX term structure, the curve that captures the difference in implied volatilities with differing maturities, on November options has since been unwound as the perception of uncertainty surrounding the U.S. election outcome reduces.
SPX 1-month and 3-month normalized skews, the difference between 25-delta puts and calls divided by 50-delta implied volatility, have also declined from recent highs.
SPX 25-delta 1-month calls are trading at approximately 10 vol, not far from all-time lows, while 25-delta puts have faded lower to approximately 15 vol, reducing the cost for investors looking to hedge against a surprise Clinton loss. In an era of high hedge-fund redemptions, central bank-induced price distortions, algorithmic trading and regulatory risks, the stock market is susceptible to large flash crash-type selloffs that would bring so-called convexity of volatility into focus.
SPX November 11 expiry, 97.5-95 percent equally weighted put spread, which covers both the FOMC and U.S. election, is currently priced at 0.32 percent. Equivalent put spread that expires on December 16 which also covers the much anticipated December FOMC meeting is currently priced at 0.53 percent.
On the rates front, event risks including NFP, Fed meetings and U.S. elections should support top-left of the USD rates gamma following recent underperformance vs the right side of the grid.
USD 2s10s 3-month swaptions implied volatility curve has steepened to an annualized 23 basis points vs 8 basis points before the Fed raised rates in December 2015. U.S. overnight indexed swap pricing shows cumulative 79 percent probability of a 25 basis points Fed rate increase in December.
RealClearPolitics average of polls shows Clinton is leading with 47.7 percent of votes vs 41.9 percent for Trump. Clinton-Trump spread at 5.8 vs July low of -1.1.
Note: Tanvir Sandhu is a cross-asset derivatives strategist who writes for Bloomberg. The observations he makes are his own and are not intended as investment advice.