Here's a Simple Way to Bet on Volatility Around the U.S. Election

(Bloomberg) -- Here's your trump card for playing the presidential election.

Right now markets aren't pricing in much volatility around the November 8 vote. The options-implied market move for the election week is just 1.6 percent, a team at BNP Paribas SA led by Edmund Shing writes in a new note, "which might seem humble" when compared to the jolts registered over other recent political events. For reference, the S&P 500 fell 2.5 percent on September 9, amid concerns that the Federal Reserve might surprise investors and raise interest rates later that month, and even notched a 4 percent drop after the United Kingdom voted to leave the European Union in June.

Looking forward, there's another overseas referendum that could deliver a shock to markets not long after the U.S. election, when Italy holds a vote on constitutional reform in December. Then later that month the Federal Reserve meets to discuss a possible interest rate hike, which the market currently puts at a better than 60 percent probability. So to put it mildly, there are a few opportunities for volatility to spike from November 8 until December 31. 

Given the market's particularly low expectation for volatility at the moment, the analysts offer a trade idea they believe will pay off if share-price movements do increase — and will work no matter which way stocks move. 

First, Shing and his team say investors should buy both bearish puts and bullish calls on the S&P 500 expiring in December, while simultaneously selling bearish puts and bullish calls on the S&P 500 that expire in November. They believe that the market is underpricing volatility in December, while overpricing it between now and November. So if volatility does increase following the election and continues to rise through year-end, the trade will become profitable, no matter if stocks move higher or lower. 

"If you're long both puts and calls, you're long volatility, because you don't care which way stocks move," Bespoke Group analyst George Pearkes explains. "Best case scenario for this trade is that there is no volatility until November and then a huge volatility spike after. The worst case scenario would be a huge volatility spike between now and November, with a collapse in volatility after."

To contact the authors of this story: Julie Verhage in New York at jverhage2@bloomberg.net, Joanna Ossinger in New York at jossinger@bloomberg.net.

To contact the editor responsible for this story: Joe Weisenthal at jweisenthal@bloomberg.net, Isobel Finkel

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