How Options Traders Are “Playing” Election Day

Stocks are soaring this morning as American voters hit the polls. The Dow, S&P, and Nasdaq Composite are all up big as of noon.

Does it mean investors expect a “blue wave?” A few weeks ago, Wall Street firms said that would be the best outcome for stocks.

Then, as Election Day drew closer, the narrative changed. It wouldn’t matter who the next president was – or even if lockdowns go back into effect – so long as the Fed was there to pick up the pieces.

“Although it has had a negative impact in the short term, the re-emergence of lockdowns and resultant growth weakness could bolster the above equity upside over the medium to longer term via inducing more [quantitative easing] and thus more liquidity creation,” explained JPMorgan analysts in a note last Friday.

“The equity bull market should resume post US election.”

That’s exactly the kind of thing that investors wanted to hear heading into this week. Especially with stocks near their September lows following a 13-session sell-off.

Some analysts remain concerned, however, that a contested election would spoil the party.

“Ultimately, the markets want clarity, and the main threat to risk assets this week is the emergence of a contested election, so if races are tight enough for campaigns to sue to halt or extend recounts, expect a reversal of this morning’s rally,” wrote Tom Essaye, founder of The Sevens Report, in a note.

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National Securities strategist Art Hogan echoed Essaye’s take on the voting results.

“A declared winner would certainly be better for these markets, agnostic of who it is,” Hogan said.

“If we wake up tomorrow and we don’t have a clear winner, that shouldn’t surprise the market. But if we’re talking about this in the middle of next week and about court cases and recounts, that’s going to be the worst-case scenario.”

“Mad Money” host Jim Cramer, on the other hand, sees a short-term dip in the near future.

“I know that sounds simplistic, but the market is simplistic,” he explained.

“We always try to make the market as some sort of Einsteinian philosophy.”

Meanwhile, Leuthold Group strategist Jim Paulsen attributed this morning’s bounce to bargain-hunting traders.

“As the election finally nears, investors who were selling on the rumor may now be buying on the news, and finally, after almost a 10% decline in the last month, buying on the dip is back,” he said.

Should the election go smoothly, volatility’s likely to drop – something that would please directional options traders. Options writers, on the other hand, want a chaotic finish to keep premiums high.

If the CBOE Volatility Index (VIX) spikes over the next few days, selling calls and puts might prove to be the best short-term trading tactic.

But if the losing candidate gracefully concedes, look out, call writers.

Because a rising market, accompanied by a plunge in volatility, could be on its way.

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