GOLDMAN SACHS: Wall Street is bracing for a historically wild stock market as the presidential election nears. Here's a surprising yet simple strategy for protecting your portfolio — regardless of outcome.

  • Investors are paying extraordinarily high premiums to hedge their portfolios around an expectedly volatile election time, according to a recent note from Goldman Sachs. 
  • While VIX futures for November are soaring, Goldman Sachs' David Kostin recommended extending hedges until December, when volatility is expected to be lower relative to November. 
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Investors are paying extraordinarily high premiums to hedge their portfolios around an expectedly volatile election time, according to a recent note from Goldman Sachs. 

The firm's equity strategists concluded this by examining prices for CBOE Volatility Index (or VIX) futures, which derivatives traders use to bet on the direction of volatility in the S&P 500.

For the November election season, futures are currently trading roughly two points higher than the previous two elections, the note showed.

Such a premium is not uncommon, considering the policy implications of election outcomes and how those impact individual companies. This time, however, the futures price bump has arrived earlier and at a larger scale than during the 2012 and 2016 cycles. 

The options market's implied volatility for November is also "extremely high," even more so than in the preceding months despite fears of deepening economic damage from the COVID-19 outbreak.

The numbers suggest that there is high demand for election-driven trades and that investors are expecting a close outcome. 

"Options market pricing suggests that the winning presidential candidate and control of the Senate may not be known on Election Day and it may take additional time to count all the votes and finalize the results," said David Kostin, the chief US equity strategist at Goldman Sachs, in the July 7 note.

"Implied volatility for the period around the November 3rd election is extremely high compared with prior cycles, primarily because of the coronavirus, but the particularly high level of implied volatility in the periods before and after the election imply an extended period of election-related uncertainty."

But while VIX futures for November are soaring, Kostin recommended extending hedges until December, when volatility is expected to be lower relative to November. 

"Although the 20-Nov option expiration offers two additional weeks of cushion beyond 3-Nov, the potential for delayed results, a precedent for extended vote-counting, and a slightly inverted term structure lead us to prefer extending hedges to the 18-Dec quarterly expiration," Kostin said.

He cites the precedent set by the delay in results of the 2000 presidential election between Republican George W. Bush and Democrat Al Gore as one reason for the extended hedge recommendation. 

"Given the several-week delay in finalizing the results of the 2000 presidential election (in addition to the contentious 1876 election), the elevated volumes of mail-in ballots used in recent primary elections, and potential for increased mail in ballots this November, we see heightened risk that election-related volatility could extend beyond Election Day," Kostin said.

Though investors seem to be anticipating a close election outcome, prediction markets indicate a sizable advantage for Democrats in the House, Senate, and presidential races. Joe Biden has a 62% chance of winning the presidency, while Democrats have 85% odds of controlling the House and 61% for controlling the Senate, according to data from PredictIt.org and Goldman Sachs.

Still, investment opportunities abound for either outcome in the presidential race.

Solita Marcelli, the chief investment officer for the Americas at UBS Global Wealth Management, said she expects industrials, tech, and utilities to benefit from a Democratic win. If Republicans triumph, she added, banks, energy, and defense stocks should outperform. 

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