Stock Market Hedging Before the Election- Are You Overpaying?

 

Throughout 2024, there have been calls by many strategists for heightened volatility in the stock market due to the upcoming Presidential election. Even the Oak Harvest Team expected short term bouts of volatility in the early first quarter and then again mid-summer. The calls for market volatility and uncertainty around the November election kept many investors who focused too much on political outcomes. Many investors kept themselves from pulling the trigger buying stocks on weakness, or worse yet, totally on the sidelines or “going to cash” throughout the year.

Lately there has been talk of hedging your portfolio for an adverse election outcome in a few weeks. I’m not sure exactly what that means. Particularly when looks at the costs of insurance versus actual market volatility?

What am I talking about? I’m talking about a bit of a technical data series I look at behind the scenes that has been quite good at defining future market moves, or at least, which way many hedgers are leaning and if it’s a worthwhile exercise to spend money to hedge.  We’ve discussed these 3 data series many times over the last few years. In order of relevance to an investor, in my opinion are the following.  They are volatility, as measured by the CBOE Vix index, which most in the media refer to when discussing market volatility.  As a reminder, the CBOE Volatility Index (VIX) is a calculation and untradeable.  It is meant to represent the market’s expectations for near-term price changes of the S&P 500 cash index (SPX). within a 30-day forward projection of volatility.

The second measure of volatility is realized volatility, or RVOL. This is a measurement of the actual volatility in the SPX index over the last 30 days. This is also called historical volatility. This is the volatility you see on your screen when you watch stocks on CNBC or Bloomberg, or on you sit in front of your screen day after day.

Finally, is my favorite measure of volatility, its Vol index futures. This is the market for traders to trade their beliefs of what volatility will be out in future months. To me, this is a particularly good measure of the true cost of insurance in future months.  It isn’t some math equation based on a basket of index puts and calls.  Its traders forward expectations of the future, and you are charged accordingly to wager or hedge, or protect your portfolio against volatile market moves.

Many market strategists have thrown up alarm warnings most of the year, warning of stock market risk around the election. The work our team has done throughout the year has said, much of the “risk” in the markets that others have been warning of, that has kept many investors from investing and enjoying some if not all of 2024’s 20%+ year to date index gains, had mostly been priced in already. And 2024 would likely turn out to be a very normal and good year for the markets.

I’ve noted the same thing since the year started.  What’s that?  It’s that almost everyone is already nervous and hedged with the same time frame insight.  They have been all year. The insurers and market makers in the volatility markets have been charging investors near the exact same premium all year for the time period most are worried about.

We’ve shared this chart and table before, but here it is again.

Here is a chart of the relative moves in realized volatility “RVOL”, what is actually happening in the markets.  The spot VIX index, or what the math majors who don’t trade say volailty might be the next 30 days, the forward volatility future, continuous contract for about a week right in front of the presidential election. The October expiration which was the 16^th, 2 days ago.  I’ve also added the Vol future for November expiration which is after the expiration.

The first chart here plots the absolute level of each.

RVOL, actual volatility is in white. Spot VIX index calculation is a yellow plot like a warning flag but not predictive. The October vol futures contract for pre-election is in red, as if it’s the warning most strategists have been given all year, and the post-election volatility contract for November is in Green. Kinda representing the supposed exhaling of concerns post-election.

Here is the same data plotted as % changes from January 1^st through the year.

As one can see, actual volatility in stock prices as of this filming on Monday was down over -14.5% YTD.  Yes investors, your emotions and eyes deceive you. Stock price movements are lower now than at the beginning of the year when the election was less a worry for most. This while spot vol is up -32.7% since then and the volatility for the pre-election time ending this week is essentially flat at up +1.2%.  In other words, the cost to insure your portfolio for the election period, at the beginning of the year and now are nearly identical. While the cost of hedging for post-election turmoil that most talk of? The economic, political, and market forecasting doomers, those waiting on “The event” to get invested? Down over -6% since early Jan.

And the SP500 has gained how much year to date? Over 22% in price and +23% in total return including reinvested dividends. Here’s that plot YTD.

As one can see, realized volatility at the beginning of this week was under 10!  Yes folks, with the markets at ATH up over 20% and the election approaching in 2 weeks, actual market volatility is nearing its low for the year at under 10.  War’s in the Middle East?  Presidential candidates dropping out and being replaced? The other candidate being shot at? Japanese Yen carry trade implosion?  AI investment cycle hype or not? And? New ATH in stocks and virtually new low in realized, actual volatility.

On the other hand the continuous contract for October expiration (UXV4) has been nearly the identical price throughout the year.  As of this writing its priced around 20 and throughout the year any time it has risen to between 20-22, sellers of volatility come in and buyers of the S&P500 show up.  It happened on the early 1q24 pullback, again during the April decline, and in a big way during the Yen carry trade panic in early august.  Will it happen again and buyers “buy the dip” on any political panic or 3q earnings weakness in the overall market?  Our indicators continue to say, yes, it wont be different this time and regardless of what you heard on TV since late 2022 and again in 2023, it’s still a bull market, until it proves it isn’t.  And investors, in my opinion, 2024 has been one of the most hated bull market year runs I’ve seen in my 35+ years in the business.  Why do I say that?  Because it’s costing you 2x actual market volatility to insure your portfolio.  It has cost you between 20-22 vol all year to insure yourself for the election.  The market makers have known all year that investors would be fearful and made you pay up.  Even back when spot vix was near 20 in April, it cost you about 21 volatility to hedge for the election.

I have found over the last 20 years of investing, that while never perfect, nothing is in investing, its very very very rare for the market makers who traffic in the forward volatility markets, the volatility insurance salesmen I call them, to misprice future market risks outside of black swan events like Covid pandemics or other unpredictable events.

In fact, if anything, my work says, most of these hedges will expire worthless and cause market participants to cover higher, or at least pressure stock prices, higher for longer in 4^th quarter 2024 through early 2025.  This is actually the reason, I’ve actually mentioned that the math behind the market says that not only was 5800 year end SP500 likely to low, but the 6000 end of January 2025 which we first discussed in October of 2023 was also likely to low by 200+ points.  Investors, it’s a bull market, until it proves it isn’t.

If you are uncomfortable with wider range of possible equity outcomes, the Oak Harvest team has launched a new strategy that retains the ability to go long stocks, short stocks, as well as buy partial hedges and shock absorber for a stock portfolio.  You can Google “OHFGX Oak Harvest” or find information on this new strategy of ours can be found at OakHarvestFunds.com.

https://www.rbcwealthmanagement.com/en-us/insights/the-push-and-the-pull-of-us-earnings

Do you need a retirement plan that goes beyond allocating funds to truly fit your needs? We can help you create a retirement life plan customized for your retirement vision and legacy. Call us at 877-896-0040 @@or fill out this form for a free consultation: https://click2retire.com/Connect