Wall Street hedging costs hit a new low for the year! A veteran trader says the midterm election risks are underestimated, making it the right time to buy "insurance."

Wall Street hedging costs hit a new low for the year! A veteran trader says the midterm election risks are underestimated, making it the right time to buy "insurance."

The potential political turmoil risks of the US midterm elections are being clearly ignored by the market, while the current low volatility provides investors with a rare window to position their portfolios for protection in advance.

In his latest market column, The MacroTourist, former institutional derivatives trader Kevin Muir points out that the market is seriously underestimating the probability of a contested election result or even political turmoil, and the current pricing in the options market does not fully reflect this tail risk.

As markets calmed in August, the implied volatility of S&P 500 put options has fallen significantly from its July high. Muir believes that the calmer the market, the lower the cost of protecting positions. However, once election risks truly enter asset pricing, volatility could rise rapidly, significantly increasing the cost of hedging.

Therefore, his advice is quite straightforward: now is the time to gradually buy portfolio protection. "The best time to buy insurance is when nobody wants to buy it."

The risk of election disputes has been underestimated; political turmoil could impact the market.

Muir's core logic is built on the current polling situation. Polls generally show that Trump's approval rating has declined, Democrats are expected to regain the House of Representatives, and Republicans are expected to retain their majority in the Senate.

However, Muir believes that what the market is truly ignoring is not the election results themselves, but rather the potential political and legal disputes that could arise if the results are challenged. He argues that the market has severely underestimated the likelihood of Trump launching a strong reaction and challenging the results in some districts if the final outcome is unfavorable to him.

In this scenario, Trump could launch legal challenges against every “contested” district, delaying the election certification process and triggering a wave of media reports surrounding “what’s next” and “election theft”.

Muir believes that this political uncertainty could eventually spill over into financial markets, driving a rapid increase in volatility. For the markets, the most dangerous thing is not necessarily a victory for one side, but rather the prolonged uncertainty surrounding the election results.

Volatility falls to its lowest level this year, and protection costs are low.

Current option pricing is providing investors with a relatively inexpensive hedging window.

As the market calmed down in August, the VIX fell to its lowest level this year, and the implied volatility of S&P 500 put options also declined. The implied volatility of the November contract fell below 15%, while the December contract was around 14%. Using implied volatility as a key parameter for option pricing, a level of 14% to 15% implies that the market expects the S&P 500 index to fluctuate by an average of approximately 0.875% per day, which is generally in a historically low range.

Muir believes that this low-volatility environment is ideal for gradually building portfolio protection. This is because once the market begins to repricing political risk, volatility tends to rise very quickly, and by the time risk truly becomes the main trading theme, hedging costs may have already increased significantly.

Seasonal factors and overheated sentiment surrounding AI create additional pressure.

In addition to election risks, seasonal factors could further amplify market volatility. Muir, citing research from Citadel Securities and Barclays strategists, points out that historically, September and October are typically the two months with the worst risk-adjusted returns for the S&P 500, and the VIX tends to rise during this period.

Meanwhile, Muir remains wary of the continued surge in the AI sector. He cited Nvidia's acquisition of Hugging Face as an example, pointing out that while market optimism regarding AI deals remains strong, some indicators, such as widening credit spreads, have already released warning signals.

However, in Muir's view, none of the aforementioned risks are as alarming as the potential for disorder in the midterm elections. When the market pays almost no premium for this tail risk, the low volatility itself constitutes a worthwhile hedging window.

Risk warning and disclaimerInvesting involves risk; please exercise caution. This article does not constitute personal investment advice and does not take into account the specific investment objectives, financial situation, or needs of individual users. Users should consider whether any opinions, views, or conclusions in this article are suitable for their specific circumstances. Any investment decisions made based on this information are at your own risk.