Our Election Trade Beats Binary Options

Our Election Trade Beats Binary Options

“Sometimes the early bird gets the worm, but sometimes the early bird gets frozen to death.”

Myron Scholes

Donald Trump had a resounding victory with an accompanying red wave in the Senate. Amazingly, and against the odds of most predictions, Trump even won the popular vote. Risk assets rallied hard on the news, and the removal of uncertainty and Trump’s pro-corporate tax policy helped lift the markets into their biggest rally in months. As of about 6:20 am EST, markets were up considerably.

The Dow was up by more than 1,300 points and all the other major indices were up considerably as well. Treasuries, on the other hand, were down on the news of the Trump victory. We have written about how bond vigilantes may be able to push US Treasuries around because of the scale of Trump’s unfunded populist promises. The divergence between bond volatility and equity volatility should now widen, and it will eventually resolve. But President-Elect Trump may still have time to pacify the bond market before Truss-esque bond vigilantism occurs.

This is the biggest risk to derailing a typical seasonal rally because Trump doesn’t need Congressional approval for most of his tariff proposals. The bond market hates radical change, and this policy would be the most radical change in how the US government collects revenues in modern history.

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Source: Penn Wharton Budget Model

The 10-yr treasury had moved up about 13 bps on the news of Trump’s victory, a huge move. It could go up even more if the Republicans end up capturing the House as well. Markets tend to like divided governments, particularly bond markets. The Republican sweep coupled with a fiscally liberal platform is the biggest risk for markets going into this holiday season. The chances for Middle East escalation have diminished because Iran won’t want to counterattack Israel with Trump in the Oval.

The Republican sweep is probably preferred to the alternative by stock markets, but we should start to see a divergence in bond market volatility which I believe will stay elevated or even rise and stock market volatility which should experience a significant post-election implied volatility crush. Realized volatility has been persistently lower and now that the election short is gone, I believe we will get what my friend Seth Golden calls “the opposite of Vol-mageddon.” If this occurs, we have several positions that will pay out nicely.

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Source: Wei Le, Black Rock

Risk assets are more amenable to the promise of higher economic growth and lower taxes a Trump Presidency is expected to bring. The question is whether this optimism can stave off a bond market that will surely attempt into Trump’s fiscally liberal platform. Bond volatility began rising as Mr. Trump’s odds began rising in prediction markets.

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One particularly interesting thing to observe in the coming Trump presidency, particularly given the strength of his mandate, is whether the President and a Republican Congress actually move to limit Fed independence as Trump has threatened in the past. As for now though, the US dollar has strengthened considerably on Trump’s wins and traders have paired back their bets for interest rate cuts for the next year. There will be an initial volatility crush, which we have positioned for well. But I’m wondering if we get some unusual seasonal bumpiness at the hands of the bond market. We’ll keep an eye on the VIX/MOVE divergence.

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Given the unfunded and unproven nature and massive scale of Trump’s promises, it is a distinct possibility that they could cause a sell-off similar in severity to what happened in October 2022. We hope we are wrong, but Trump’s current proposals for paying for his policies expand the deficit enough to mitigate or eliminate the benefits of greater economic growth that his platform is expected to initially provide. The bond market often shoots first and then asks questions later and even if Trump’s policy has the desired effect of spurring a manufacturing boom, it cannot accomplish this objective quickly. Markets will doubt the viability of this radical departure from current US government revenue collection practices.

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Source: @SethCL

So rates could be rising for three reasons, and it’s probably a confluence of multiple drivers.

  • Firstly, economic growth numbers have been coming in persistently which produces higher rates on higher growth expectations.

  • Secondly, since tariffs are inflationary, they could raise inflation which raises long-term rates.

  • Thirdly, Donald Trump’s platform is mostly unpaid for and this makes US debt less valuable and its hallowed position potentially assailable.

That’s why I advised the largest modern sell-off of US Treasuries could occur if the bond market starts getting stern on Trump’s unfunded promises. But there are also some positives for equity volatility. Since people are over-hedged, we should be getting a massive and potentially sustained collapse in volatility. We got this trade just in time, and it would have seemed insane yesterday particularly given its low time to expiration. But I think we’ve successfully demonstrated that you can use VIX options to play volatility events better than the shabby binary products being sold at brokerages.

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I am proud because we gave you a trade on the election with far higher upside than the binary options contracts most people use to bet on elections. It was also a trade not dependent on which candidate won, only that one did so decisively. Implied volatility moves faster than price, and we made a bet that the election outcome would be certain by morning, and it panned out. It also panned out a lot better than most people who made money in the prediction markets. As of the open, our trade had gained 122% in less than 24 hours. That’s the Punk Rock Traders way.

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