Democratic upset in U.S. midterms could roil markets, options mavens say

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08/11/2022 06:00

By Saqib Iqbal Ahmed
       NEW YORK, Nov 8 (Reuters) - An unexpected result in
Tuesday’s U.S. midterm election could roil markets positioned
for relative calm, options strategists said.
    Control of the U.S. Congress is at stake in Tuesday's
midterms, with Republicans favored by polls and betting markets
to win control of the House of Representatives and possibly the
Senate. With Democrat Joe Biden in the White House, that
potential result would lead to a split government, an outcome
seen as broadly favorable to markets over the long term. 
    But a surprise victory by the Democrats could throw the
markets for a loop, potentially bringing to the fore concerns
about tech-sector regulation as well as budget spending that
could buoy already-high inflation, according to market
participants. 
    Analysts said a calendar full of closely watched
macroeconomic events such as last week’s Federal Reserve meeting
and U.S. consumer price data later this week have left traders
less focused on the vote than might normally be the case. 
    With investors' election-related hedging comparatively
light, "any surprise would probably be exacerbated by thin
markets and the relatively high volatility landscape that we are
looking at right now," said Chris Murphy, co-head of derivatives
strategy at Susquehanna International Group.
    Options positioning implied a 1.5% decline in the S&P 500 on
the day after the vote should Democrats pull off a
stronger-than-expected showing, according to Tom Borgen-Davis,
head of equity research at options market making firm Optiver.
    A "big Democratic win could be taken negatively for the tech
sector just given they are more likely to bring in regulations
in the sector, relative to Republicans," Borgen-Davis said.
    That said, options traders do not seem to be positioned for
fireworks. For example, open puts on the Nasdaq 100-tracking
PowerShares QQQ Trust's  QQQ.O  options, typically used for
defensive positioning, outnumber calls, usually employed for
bullish wagers, 1.4-to-1, one of  the smallest margins since
mid-June, according to Trade Alert data. 
    Meanwhile, the Cboe Volatility index  .VIX , known as Wall
Street's fear gauge, fell on Monday to close at a near two-month
low. The SPX rose 0.96% but is still down 20% for the year.
    Strategists at Morgan Stanley including Mike Wilson wrote on
Monday that a Democratic win could send Treasury yields higher
and strengthen the dollar, reflecting the view that higher
fiscal spending could exacerbate inflation and force the Fed to
raise rates higher than expected.
    "Markets could assign a higher probability to further fiscal
expansion, with Congress and the Fed effectively pulling in
opposite directions on inflation," Morgan Stanley's analysts
wrote. 
    On the other hand, a clean sweep by the Republicans could
increase the chances of a Republican spending freeze, boosting
Treasuries and supporting the most recent rebound in U.S.
stocks, which has sputtered this month, according to Morgan
Stanley.
    At the individual stock level, certain names have the
potential for higher election-related volatility, strategists at
Goldman Sachs said in a note earlier this month.
    For instance, revenue at iHeartMedia Inc  IHRT.O  Fox Corp
 FOXA.O , Paramount Global  PARA.O  and Meta Platforms Inc
 META.O  could potentially get a short-term boost from
ad-related spending around midterm elections, according to the
report.
    Meanwhile, shares of tobacco company Philip Morris
International Inc  PM.N  could be volatile around regulatory
restrictions, Goldman’s analysts wrote.
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GRAPHIC: Ebbing fear    https://tmsnrt.rs/3WEzPQV
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 (Reporting by Saqib Iqbal Ahmed in New York
Editing by Ira Iosebashvili and Matthew Lewis)
 ((saqib.ahmed@thomsonreuters.com; @SaqibReports; +1 332 219
1971; Reuters Messaging:
saqib.ahmed.thomsonreuters.com@reuters.net))