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Vol reset trades abound as Clinton victory prospects rise

Derivatives markets across asset classes are projecting increased confidence of a Hillary Clinton win in Tuesday's US presidential election, but also revealing concern that volatility could then evaporate from markets for the rest of the year.

Equity, credit and FX volatility rose at the end of October, as a shift in polls towards Republican candidate Donald Trump sent tremors through derivatives markets. But there has been a reversal since Friday as traders shook off jitters that were partially amplified by the UK’s shock EU referendum result in June.

“This week has been in sharp contrast to last,” said one equity derivatives official at a bank in London. “We are coming off the longest streak of S&P [index] down days and VIX up days. It got very tense last week but completely reversed Monday and today.”

Equity index volatility is still elevated, the banker noted, with the CBOE VIX around 19.4% but in from 21.9% on Friday. But the majority of derivatives traders are now more worried about volatility resetting to the extreme lows it traversed over the summer.

“People are looking at the risk of a big volatility reset,” said the banker. “We have seen a lot of vol normalisation trades, such as VStoxx puts. VIX puts had their most active session of the year on Friday and we are seeing people rolling long vol positions from November to December. Meanwhile, skews if anything are steeper now than they were on Friday.”

Partially this shift in focus to December is because a US rate hike would become more likely with a Clinton victory. But traders said that even this event is increasingly priced in to equity market volatility measures.

“That might not be enough to choke things up,” said one strategist.

Credit and equity markets were more cautious ahead of the US election than they might have been without the unexpected result of the UK's decision to leave the EU in June, said market sources. But recent trading dynamics suggested only a 2% move higher for stocks on a Clinton win, they said, versus a 5% drop if Trump prevails.

In credit, one strategist predicted a 10bp to 15bp widening in CDX IG if Trump wins. The index has outperformed its European counterpart iTraxx Main since the start of November, and narrowed the gap from 5bp on November 1 to 3.5bp on Monday and just 2.25bp on Tuesday morning, with IG quoted at 76.75bp and Main at 74.5bp.  

“There is more nervousness in Europe about a Trump win than in the US,” said the strategist.

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