As the U.S. stock market continues to rally to record highs, the attention of many investors is turning toward November’s elections as a source of risk. Hedging against that potential market volatility does not come cheap. In fact, it’s currently the most-expensive event risk on record based on a common way to bet on volatility known as a “butterfly trade.”Futures tied to the CBOE Volatility Index expiring in late October closed yesterday at 33.5, compared with a spot VIX that closed at 26.1. Those October contracts, which are currently the second-month futures and reflect expected volatility in the month after they expire on Oct. 21, are also higher than the first-month futures expiring in September and the third month expiring in November.
One “butterfly” trade would be to buy one unit each of the first- and third-month contracts while selling two units of the second. Currently, that trade prices with a reading of -6.9, the difference in costs between the butterfly’s “wings” in September and November and the “belly” in October. That pricing reflects the premium that investors are giving to own volatility over the election. Trading of VIX futures started in 2004.
In the history of the VIX futures contracts, we’ve never had an event risk command this sort of premium into forward-dated volatility at a specific tenor. Less risk is being priced in in international stock volatility and the in the MOVE Index, which is like the VIX for Treasury Bonds.
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