Intro From Chris Robb, our Head of Research: We have made what I believe is the most successful publicly posted election day trade of the season. It is now up 200% in less than three trading sessions. We shorted the CBOE Volatility Index on election day, betting an implied volatility crush was likely. While this seems like a harrowing call, we had history on our side. There was an 80% probability of an implied volatility crush and we also bet it would be one of the largest in history on the basis that the election would be decisive. Importantly, our bet was not dependent on which candidate won the election and does not have upside capped, like the shabby binary options a lot of people used to bet on the election. My former Fundstrat colleague and current Punk Rock Traders Affiliate Jack Runge does an excellent job of explaining why our election day bet actually had about the same odds of succeeding as if you flopped pocket queens in Texas Hold Em’.
Any time there is a predictable pattern in the public psyche, that presents an investment opportunity that could be worth taking advantage of. Finding and recognizing these patterns effectively gives an investor an idea of what the future will look like, and it’s self-evident that being able to predict the future would be the ultimate investment strategy. US elections present one such predictable pattern.
United States elections signal a significant shift in my fellow countrymen’s attitudes, expectations, and lives for the mid-term future of our country and its economy. Because of this, especially with the heated rhetoric that contemporary politicians are using to drive voters to the polls, election season introduces a lot of uncertainty in the American public, especially in equities markets. The beautiful thing is, once the elections are over, the world gets at least some increase in clarity for what the future could look like.
The pattern here is simply:
Pre-election, uncertainty goes up.
Post-election, uncertainty goes down.
The VIX is a vehicle that, in effect, measures uncertainty in the market. Its calculation is generally based on the difference in S&P futures contracts that execute the soonest vs. the next, and then uses that difference to imply the volatility of the market’s expectations. The way that it effectively measures uncertainty is that, when uncertainty goes up, volatility follows. And when uncertainty goes down, so does volatility.
Combined with the pattern from before:
Pre-election, uncertainty goes up, so the VIX goes up.
Post-election, uncertainty goes down, so the VIX goes down.
As evidenced by the performance of Chris’s pre-election VIX short trade idea, this pattern can be a very fruitful investment opportunity. But for more evidence of this, Table 1 below provides the historical VIX returns pre- and post-election going back to 2004, which is the earliest that TradingView has reliable VIX data.
Table 1. VIX returns pre- and post-election for every US election since 2004
Table 1 shows that, while it may be unreasonable to purchase VIX calls prior to an election, it would be a safe bet to purchase VIX puts just beforehand. In the 10 elections the US has had since 2004, the VIX has been down 80% of the time, which would be a worthwhile bet to make if you asked me. It is also worth noting that almost every singe time, there were opportunities to take handy profits on a VIX put at some point in the month following an election. In fact, there was a double digit drop in the VIX in the month following a US election 10 out of 11 times since 2004. The only exception to this was in 2008 during the Great Recession that dragged markets down into March 2009.
The takeaway here is, if the US economy is not in the midst of an economic collapse during an election cycle, a risk-seeking, pattern-recognizing punk rock investor should buy VIX puts within a week of a US election, and then set a point to cash out for hefty profits, like a double digit drop in the VIX for example. As for specific entry points, honestly any major spike up in the VIX in the one or two weeks prior to an election would be prime candidates (The 13.82% jump on Halloween this year being a perfect example).
Going back to Table 1, a red box signifies an opportunity to make a quick gain by shorting the VIX, and I’m seeing a lot of red. So next time Chris publishes a VIX short trade idea around an election, join in on the fun and retire early.
