Volatility Ahead – Navigating Election Ups and Downs
The headlines keep rolling, both good and bad, at a seemingly alarming pace. However, that’s a reflection of what 2020 has become known for. Now, we sit just four weeks away from the elections. What’s in store for the investment world?
The short answer: More of the same. And by the same, we mean volatility. You can see this below.
Source: CBOE.com. Data from 10/1/20 through 10/5/20 are actual VIX levels. Other data is based upon futures contracts priced as of 10/5/2020.
The above shows how the volatility index (VIX, also known as “The Fear Index”) is trading currently and where the futures contracts are priced in the coming weeks and months. Here is what is showing up in this data:
- For context, volatility is already at a higher level than normal. The VIX average since the beginning of 2010 is 17.4 versus the current level of just shy of 27. Elevated volatility has been true since the pandemic started and is still showing up in daily data.
- Volatility is priced to go even higher. You can see the line above gravitating up. This is happening leading up to the election. However, after the election, volatility doesn’t immediately dissipate. That’s because there is still potential for an unknown outcome or some form of debate over the results. From an investment perspective, the important part of the curve above is to know what the market is telling us. Let’s say you have the thought the market will become more volatile as we approach the election. We’d agree with you. Can you profit from that belief? You could buy a futures contract on the VIX to make the bet of “I think the VIX will be higher leading up to the election than it is today.” However, because of the pricing structure of these investments, to make that bet, you are buying into a VIX level in the futures market that is already higher than today. In fact, if you buy the end of the month contract, you pay a price that is over 17% higher than it is today. Why? The market thinks the exact same thing as you and me already, so this expectation is priced in. In reality, to “win” on this bet, not only would the VIX have to go higher than it is today, but go higher than you and the market already thinks it will.
- Volatility doesn’t mean negative returns. As we’ve seen since the end of March this year, returns have been great, but volatility has persisted. This just means the daily moves of the market are a bit more than typical.
Past performance may not be indicative of future results. Different types of investments involve varying degrees of risk. Future performance of any investment or wealth management strategy, including those recommended by Balasa Dinverno Foltz LLC (BDF), may not be profitable, suitable for you, prove successful or equal historical indices. Historical indices do not reflect the deduction of transaction, custodial or investment management fees, which would diminish results. Any historical index performance figures are for comparison purposes only and client account holdings will not directly correspond to any such data. BDF clients must, in writing, advise BDF of personal, financial or investment objective changes and any restrictions desired on BDF’s services so that BDF may re-evaluate its previous recommendations and adjust its investment advisory services. BDF’s current written disclosure statement discussing advisory services and fees is available for review at www.BDFLLC.com or upon request.
Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this commentary serves as the receipt of, or as a substitute for, personalized investment advice from BDF.
Created by the Chicago Board Options Exchange (CBOE), the Volatility Index, or VIX, is a real-time market index that represents the market’s expectation of 30-day forward-looking volatility. Derived from the price inputs of the S&P 500 index options, it provides a measure of market risk and investors’ sentiments.The S&P 500 Index includes a representative sample of the largest 500 companies in the U.S.