It is the need of the hour to provide a trading perspective on the largest democratic exercise on the planet which is about to get under way in a few weeks. As is typical of such times in any Parliamentary system, there is plenty of commentary available about campaign management, potential seat sharing, likely results, and post- election power equations. However, what is singularly lacking is any mention of what the implications are for market participants, who actually risk their own and their clients’ savings on the market’s gyrations on a daily basis.
It is not the objective of this article to speculate on the results of the election. None of the analysis herein makes any assumption of the potential identity or scale of wins or losses. Our focus is on generic trading strategy, irrespective of who wins and who loses the election. In terms of strategic positioning, let us classify exchange based traders into “news traders” and otherwise. The former are clearly those who expect to benefit from a change in the value of some
stock or index from a sudden directional burst caused by the shock effect of some news item. Since election news is broad based, the most likely security to be affected is an index.
Clearly, the case is plain for the rise to prominence of broad based indexes and their derivatives at such a time. We anticipate that futures and options on indexes would be most preferred now until well into May. Analysing further, If the impact of the news on an index is expected to be positive it would create volume in the long speculative positions such as long calls or long futures on the index. If the reverse is true it would imply a loss in value, leading to trading volume in short speculative positions such as short calls, short futures or long puts. The last aspect is tenor. It makes eminent sense for news traders to gravitate towards weekly options, which have swift expiry and can fully deliver results on the news without drawing the option out and making traders lose inordinate amounts in time value. It is no surprise that the market has seen a recent increase in trading volume on weekly options on indexes. We see this trend certainly continuing into the last of the post-election capture of news effects.
So what is the ideal option position to take for any trader irrespective of direction of impact? There clearly are a few strategies: long straddles, long strangles and butterfly spreads, all of which can be created directly or synthetically depending on the margin appetite of the trader or client. Our first majortrading observation is that weekly options are clearly going to see further jumps in volume, as the news around the election keeps coming thick and fast. We expect its crescendo will be around result declaration, after which pure news based trading will be replaced by less
instantaneous impacts.
So what of non-news based traders? Given the election month is approaching we will see increased uncertainty, leading to increased volatility, and in index futures and options, only not restricted to the weeklies. Increased volatility should deliver better valuations on options for both calls and puts. Again, the same strategies as with the news trades: all round spread positions – call spreads, put spreads or butterfly spreads on index options are where the smart money will gravitate towards and dominate volume for the next two months at least.
