With the upcoming US election, we have been asked by our clients whether the market is pricing in any signals around the election date on the 5th of November. While Coremont does not express any view on who will win the election, we decided to explore how the uncertainty of the event, or indeed the anticipation of one candidate versus the other, might be visible in the implied volatilities of equity options. Given that it’s a US event, it felt natural to look at S&P 500 (SPX) options. To explore this idea, we developed a new model to remove noise from the market volatilities and to distinguish the market’s expectation of the volatility around the event. This short blog is to share our findings.
The input data for the model is the At The Money Forward (ATMF) implied volatility term structure of the SPX Index. To ensure we capture market-implied volatilities daily for at least one month from the calculation date, we use weekly options in the analysis, as they expire daily. We use the ATMF volatility to represent the volatility because, among all strikes, it is the one that reflects the ‘fair level’ of volatility for a given maturity date (the level of volatility assuming no skew and no convexity).
The model used to fit the market volatility term structure is a time-continuous functional, combined with a jump process to capture the jump around the US election date. The model satisfactorily calibrates to the market term structure. See Figure 1 below.
Using the calibrated model, as of 2nd October 2024, we can price that the markets are anticipating a daily volatility at around 46.59%, on 5th November, in case the US election outcome is not the one the markets practitioners would prefer. This would be around four times the usual overnight volatility level, on SPX Index as you can see on the below figure 2.
We can estimate that 46.59% volatility is consistent with the S&P 500 price dropping by about 5.23%, overnight. We predict a depreciation because the Equity underlying price is usually negatively correlated to the volatility.
For the calculation details regarding the move estimation please refer to this: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2808168
