Traders load up on market insurance on fears of a contested election
The chances of a contested presidential election are on the rise, and traders are gearing up for big market swings after the Nov. 3 contest. Futures contracts that track the Cboe Volatility Index ( VIX ) that are set to expire after the election are holding at elevated levels. The VIX futures contract set to expire Nov. 18 — 15 days after the election — is trading above 31, according to FactSet. VIX futures contracts expiring Dec. 16 and Jan. 20 are trading above 28. It isn't until the March expiration that the futures curve start trading back below 28. Normally, VIX futures contracts expiring after the election trade at a sizable discount to the contract that expires just before the contest. This is in part because it's usually clear who the winner is on election night. This time, however, traders are bracing for a protracted period of wild market swings after the election as more people are expected to vote by mail because of the coronavirus pandemic. This means it could take longer for the official results to be determined. "Right now the market sees a significant, drawn-out level of volatility" after the election, said Bill Looney, managing director and head of global business development at XFA. "This heightened sense of uncertainty around the outcome of the election is palpable." In recent months, President Donald Trump has raised concerns that expanded mail-in voting could lead to electoral fraud. In May, he threatened to hold up funding to Michigan and Nevada for expanding vote-by-mail access . Last month, the Trump campaign sued New Jersey for its decision to send mail-in ballots for the November election. On Aug. 23, Trump tweeted: "The greatest Election Fraud in our history is about to happen." Trump himself voted by mail in Florida's primaries in March and August. Trump's claims come even as a recent analysis casts the risk of voter fraud by mail to be minuscule . "Trump is basically setting the market up for a contested election," said Looney, who added that institutional traders have recently increased positions to account for a post-election volatility spike. Election Day itself is also shaping up to be a choppy day for markets. Data compiled by Goldman Sachs shows the options market is pricing in a 3.2% move for the S & P 500 on Nov. 3. "The heightened concern about the virus trajectory, vaccine development, and elections are all reasons for high vol risk premium, but we see options as underpriced for short-dated maturities and overpriced for the period around November's election," Goldman strategist Rocky Fishman said in a note. Traders may be getting a preview of what that volatility may look like after the market's recent run to back to record levels. On Tuesday, the Cboe Volatility Index traded above 33, near its highest level since June, before sliding back to 29.8 on Wednesday. The VIX has been rising since last week as investors cash in profits from tech, the best-performing sector in the market year to date. That volatility increase also comes as Trump has slightly narrowed his gap against former Vice President Joe Biden. Data compiled by RealClearPolitics shows Biden leading Trump by an average of just over 7 percentage points in national polls. However, that's down from a 9.3 point gap in late July. "The political polls have recently suggested that we may have a too close to call unresolved presidential election on November 3 causing unrest at home and a lack of confidence in the U.S. from foreign investors," said Bruce Bittles, chief investment strategist at Baird. It's not just professional volatility traders that are bracing themselves for a protracted election battle. Phil Blancato, CEO of Ladenburg Thalmann Asset Management, said he's been rotating client portfolios into "higher-quality fixed income and equity, because I expect it to come and I don't want our clients to feel those waves of volatility." "I am very concerned about a contested election," said Blancato. "There are some significant concerns about what happens socially, and economically, during a contested election and what that would do to the fabric of this country, which is already strange. I'm very worried about the election and I hope one of the two candidates wins by a significant amount."

A pedestrian carries an umbrella while walking in front of the New York Stock Exchange, Feb. 26, 2020. Michael Nagle | Bloomberg | Getty Images