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Post-Election Lessons in Volatility

Post-Election Lessons in Volatility 

BY: HANS ALBRECHT, CIM®, FCSI, VICE-PRESIDENT, PORTFOLIO MANAGER AND OPTIONS STRATEGIST, HORIZONS ETFS

Early in November, I suggested that investors consider adding BetaPro S&P 500 VIX Short-Term Futures™ Inverse ETF (HVI) to their portfolios. It was for a good reason: option pricing, and importantly downside put skew, was very high. In fact, it was much higher than the actual market movement indicated was ‘fair’. So, as I said to Bloomberg, “fade the fear, markets will digest it.”

However, option pricing doesn’t just describe what is happening now – it also attempts to price market movement going forward, and with an uncertain election result hanging in the balance, anything could have happened. Brexit taught us that the value of polling isn’t necessarily worth a whole lot; it only works when participants express their true intentions. A funny thing happened on the way to Hillary Clinton’s all-but-certain win: Trump pulled it out in dramatic fashion. While I didn’t think he could truly do it, part of the HVI volatility trade thesis was that once an event has passed, a great deal of uncertainty passes with it. Even with an unexpected outcome like this one, option markets breathed a sigh of relief and started searching for the next catalyst for movement. With the holidays coming and a fairly telescoped rate hike on the way, shorter-term option pricing has been trading down sharply from pre-election levels.

Direction of outcome often doesn’t matter when it comes to pure play option pricing. Buying a call or a put into an event is certainly a way to play volatility. However, as a standalone, it has an important component that you need to get right: the direction of the underlying. Using an ETF like HVI (or HVU/HUV) allows you the advantage of isolating option pricing levels without having to pick a direction for an index. As we know, option pricing is mean reverting, which signifies it can get very low and it can get very high, but ultimately it reverts to something closer to average value.

Therein lies the value in following broader option pricing levels for opportunities. This recent event is a great lesson in pricing fear: Despite an outcome that many felt would be devastating to markets, options markets were able to digest the prevailing fear.

Post-script: HVI’s pre-election price on November 4, 2016 was $11.81. Its post-election price on November 14, 2016 was $13.95.

The views/opinions expressed herein may not necessarily be the views of AlphaPro Management Inc. All comments, opinions and views expressed are of a general nature and should not be considered as advice to purchase or to sell mentioned securities. Before making any investment decision, please consult your investment advisor or advisors.

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