Deconstructing the 2024 Election Impact on Derivatives Markets: Are We Facing Another "Trump Rally" Scenario?

The United States' 2024 presidential election holds major implications for derivatives traders, and while much has been discussed about potential volatility spikes, few are truly prepared for how a "Trump-like" market event could impact portfolios. For traders working with options and other derivatives, understanding the patterns and triggers behind the 2016 "Trump Rally" could offer valuable insights as we approach another contentious election cycle.

1. The 2016 Market Phenomenon: A Brief Look Back

In November 2016, when Donald Trump won the presidency, markets were set up for significant volatility regardless of the outcome. Prior to the election, many options traders hedged their bets against a potential economic shock, assuming an unconventional candidate like Trump would destabilize the market. However, what followed was a massive rally, primarily driven by expectations of pro-business policies like tax cuts, deregulation, and infrastructure spending. The result was a steep volatility crush that unwound countless protective positions.

From a volatility perspective, implied volatility (IV) saw a substantial decline following the election results, as the market absorbed what it perceived as “positive risk.” A host of options were impacted—especially those designed to capture the downside, as the market’s knee-jerk response shifted to an optimistic, bullish outlook.

The S&P 500 and major indices surged, sending call options on equities skyrocketing while skewing probabilities. Traders who took long volatility positions were forced to recalibrate, often sustaining losses or doubling down on riskier plays. This unexpected outcome was a textbook example of how high-stakes political events can defy typical market logic, rewarding those who anticipated the unexpected and punishing those who followed the consensus.

2. The 2024 Election Landscape: Parallels and Differences

For traders, anticipating a repeat of the 2016 scenario in 2024 involves assessing both the current political climate and potential policy impacts. The 2024 election cycle presents an even more polarized landscape, where both domestic and global stakes are amplified. On one hand, a repeat of the 2016 “Trump Rally” could be possible if the market anticipates pro-business policies and a deregulation push. On the other, economic uncertainties, ranging from inflation to a still-recovering post-pandemic economy, make predicting market reactions even more complex.

One critical consideration is the Federal Reserve’s current interest rate stance, which differs sharply from 2016. With higher rates already in place, there’s limited room for rate cuts, which could dampen any rally. Moreover, the international economic landscape—rife with supply chain complexities, geopolitical tension, and energy concerns—adds another layer of unpredictability. Traders who adapt their strategies to account for these nuances could be better positioned, but as with 2016, the potential for surprises remains high.

3. Options Market Implications and Strategies

Understanding the mechanics of options trading during election-driven volatility is crucial for derivative traders. Here’s how to consider positioning:

• Implied Volatility (IV) Considerations: Pre-election, we’re likely to see a spike in IV across major indices and sectors, especially those sensitive to regulatory or trade policies. This presents an opportunity for premium sellers, who may benefit from an IV crush post-election, assuming a decisive outcome calms the markets. However, this play relies heavily on clear and conclusive election results. A close or contested election, such as in 2000, could sustain high volatility well beyond November.
• Straddles and Strangles: With the potential for a strong directional move, consider using straddles or strangles, especially in the days immediately before and after the election. These strategies allow you to profit from a significant move in either direction, regardless of the outcome. Given the high IV leading into the election, however, it may be wise to wait for any post-election dip in IV before rolling into new positions, rather than overpaying for options premiums.
• Sector-Specific Options: Focus on sectors like energy, defense, healthcare, and technology, as these could be particularly sensitive to either administration’s policies. For example, a Republican administration might favor defense and energy, potentially driving bullish options activity in these sectors, while a Democratic win might bolster green energy and healthcare.
• Hedging with VIX Futures and VIX Options: VIX products are another layer of protection, allowing traders to hedge against sharp market reactions. However, they should be used with caution, as their predictive value can be highly contingent on market sentiment and election clarity. In 2016, the VIX fell sharply post-election, punishing those who remained long on volatility products. This time, consider smaller positions in VIX futures or VIX options to hedge without overcommitting to volatility exposure.

4. The Probability of Another Trump Rally: A Calculated Bet?

While the specific circumstances of 2024 are unique, the probability of another “Trump Rally”-type event can’t be dismissed. If a pro-business candidate wins, markets could react positively once again. Yet the possibility for a repeat of the 2016 rally is constrained by several factors, notably the current economic cycle and global instability.

Additionally, if the election is tightly contested, with legal challenges or vote recounts, this could introduce prolonged uncertainty. In such a scenario, the market might react with sustained volatility rather than an immediate bullish or bearish trend, which could have profound implications for traders betting on a decisive move.

But then again, expect the unexpected. Happy Trading This Eventful Winter.

But seeing the way prepolls and Kamala Harris's speeches and word salads, it seems like a cake walk for the Trump.

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