Democratic turmoil in US midterm elections could rock markets, options experts say

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By Saqib Iqbal Ahmed

NEW YORK (Reuters) – An unexpected result in Tuesday’s US midterm elections could shake markets positioned for relative calm, options strategists said.

Control of the US Congress is at stake in Tuesday’s midterm elections, with Republicans favoring polls and betting markets to gain control of the House of Representatives and possibly the Senate. With Democrat Joe Biden in the White House, that potential outcome would lead to a divided government, an outcome widely viewed as favorable for markets in the long run.

But a surprise Democrat victory could confuse markets, potentially raising concerns about tech sector regulation and budget spending that could fuel already high inflation, according to market participants.

Analysts said a calendar of closely monitored macroeconomic events, such as last week’s Federal Reserve meeting and US consumer price data later this week, has left traders less focused on the mood than they normally would. to be.

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With investor election-related hedging being relatively light, “any surprise would likely be compounded by thin markets and the relatively high volatility landscape we’re looking at now,” said Chris Murphy, co-head of derivatives strategy at Susquehanna International Group.

Options positioning implied a 1.5% drop in the S&P 500 the day after the vote, should Democrats deliver a stronger-than-expected performance, according to Tom Borgen-Davis, chief of stock research at Optiver, an options company.

A “big Democratic win could be interpreted negatively for the tech sector just given that they are more likely to introduce regulation in the sector, compared to Republicans,” Borgen-Davis said.

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That said, options traders don’t seem positioned for fireworks. For example, open puts on the Nasdaq 100-tracking PowerShares QQQ Trust’s options, typically used for defensive positioning, outperform calls, typically used for bullish bets, 1.4-to-1, one of the narrowest margins since mid-June, according to Trade Alert Data.

Meanwhile, the Cboe volatility index, known as the Wall Street fear meter, fell Monday to close at a nearly two-month low. The SPX rose 0.96% but is still down 20% for the year.

(Image: Decreasing Anxiety, https://fingfx.thomsonreuters.com/gfx/mkt/lbvggreoyvq/Pasted%20image%201667848468559.png)

Morgan Stanley strategists, including Mike Wilson, wrote Monday that a Democratic victory could raise government bond yields and strengthen the dollar.

“Markets may place a greater likelihood of further fiscal expansion, with Congress and the Fed essentially pulling inflation in opposite directions,” Morgan Stanley analysts wrote.

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On the other hand, a clean slate from Republicans could increase the likelihood of a Republican spending freeze, boost Treasury bonds and support the latest rally in US stocks, which Morgan Stanley said sputtered this month.

At the individual stock level, certain names have the potential for higher election-related volatility, Goldman Sachs strategists said in a note earlier this month.

For example, according to the report, the revenues of iHeartMedia Inc TBEN Corp, Paramount Global and Meta Platforms Inc could receive a short-term boost from ad-related spending around midterm elections.

Meanwhile, shares of tobacco company Philip Morris International Inc could be volatile around regulatory restrictions, Goldman analysts wrote.

(Reporting by Saqib Iqbal Ahmed in New York; editing by Ira Iosebashvili and Matthew Lewis)