Beyond Polls: Why Election Market Moves Are Driven By Volatility, Not Predictions

As the US election draws near, market participants are once again grappling with uncertainty. With political tensions high and polls often shifting, many investors are opting to avoid the complexities of predicting a winner. Instead, they are focusing on a strategy that has historically proven more reliable in times of political uncertainty—volatility trading. In this article, we explore why traders are betting on volatility rather than attempting to forecast the election outcome, and how this approach is shaping market behavior.

The Limitations of Predicting Election Outcomes

Predicting election outcomes has always been a risky endeavor. Even with extensive polling data, election surprises are common, and the fallout can be significant for those caught on the wrong side of the market. The 2016 US election serves as a prime example. Most polls predicted a Hillary Clinton victory, and markets were positioned accordingly. When Donald Trump unexpectedly won, markets experienced sharp movements, leaving many investors scrambling to adjust their positions.

Polling data can be unreliable, as it often fails to capture the full complexity of voter behavior. Additionally, prediction models tend to oversimplify the outcome, ignoring the potential for last-minute shifts in voter sentiment. As a result, betting on a specific candidate winning can be a binary and highly risky proposition. With these risks in mind, traders are increasingly avoiding direct election outcome bets, turning instead to volatility, which offers more nuanced ways to navigate uncertain times.

Volatility as a Safer Bet

In the context of financial markets, volatility refers to the rate at which the price of a security increases or decreases for a given set of returns. Higher volatility means more uncertainty, and elections are known to amplify this effect. The months leading up to major political events often see heightened uncertainty as traders and investors anticipate potential shifts in government policies and their impact on the economy.

Volatility indices, like the Chicago Board Options Exchange’s Volatility Index (VIX), often rise significantly during election periods. The VIX, often referred to as the “fear index,” reflects market expectations of volatility over the coming 30 days. As uncertainty about election outcomes grows, the VIX tends to spike, signaling that traders expect significant price swings in the near future.

By focusing on volatility, traders are not trying to predict who will win the election. Instead, they are capitalizing on the fact that the election itself creates market turbulence, regardless of the outcome. This approach provides flexibility, allowing traders to profit from market swings in either direction, making it a more attractive option in such unpredictable environments.

Volatility Trading Strategies in Focus

Several volatility-based trading strategies have gained prominence during election seasons. Options and futures are commonly used instruments to bet on market swings without tying profits to a particular election outcome.

One popular strategy is the use of straddles and strangles, where traders buy both call and put options with the same expiration date but different strike prices. These strategies are designed to profit from large movements in either direction, making them ideal for periods of heightened uncertainty like elections.

Another method is to take positions on volatility indices like the VIX, either by buying futures contracts or exchange-traded products (ETPs) tied to volatility indices. These instruments allow traders to directly bet on rising market volatility, without worrying about which way the broader market might move.

For institutional investors, volatility swaps and variance swaps—more complex derivatives—provide a way to directly trade volatility itself, rather than the price of an underlying asset. This enables sophisticated investors to hedge against election-related risks while positioning themselves to benefit from the inevitable market turbulence.

The Shift Away from Traditional Election Betting

Data shows a significant increase in the trading volumes of volatility-related instruments during past election cycles. As the upcoming US election approaches, this trend is continuing. Many institutional investors, in particular, are avoiding outright directional bets on market movements tied to election outcomes. Instead, they are positioning themselves with volatility-based strategies that offer a more balanced approach to risk.

This shift reflects a broader trend among traders who have learned from past election cycles. Rather than trying to predict the unpredictable, they are focusing on what they can control—how to profit from the inevitable market swings caused by heightened uncertainty.

In the 2020 US election, for example, even though Joe Biden led most polls leading up to election day, traders continued to place heavy bets on volatility instead of banking on a clear outcome. This approach paid off as markets saw significant fluctuations in the days before and after the election.

Implications for the Broader Market

The increased focus on volatility trading has broader implications for financial markets. For one, it adds liquidity to options and futures markets, as more participants enter these trades to hedge against election risks. This, in turn, can lead to more stable pricing for these instruments, which benefits all market participants.

On the flip side, heightened volatility trading can create short-term instability in broader markets. As more traders position themselves for market swings, it can result in sharper price movements for equities and bonds, particularly in the days surrounding the election.

Looking ahead, the outcome of the US election will likely continue to drive market volatility, but the extent of market movements will depend more on the levels of uncertainty than the actual results. Traders focusing on volatility are well-positioned to weather these market shifts, as their strategies are built around capitalizing on swings rather than depending on a particular candidate's victory.

Conclusion

As the US election approaches, volatility has become the trade of choice for many investors. Instead of trying to predict the outcome of what could be a highly unpredictable election, traders are focusing on the one thing they know for sure—market uncertainty. By employing volatility-based strategies, they are positioning themselves to profit from the inevitable swings in prices, regardless of who wins. In an era where polling data and election predictions can be unreliable, betting on volatility has proven to be a safer and more flexible approach to navigating election-driven market turbulence.

Author: Brett Hurll