Investors are having to get more creative with their election hedging strategies.

With the cost of put options on the S&P 500 as much as 50% more expensive than a month ago, those concerned over the potential for the election to disrupt markets are considering a number of different trades, said Michael Schwartz, chief options strategist with Oppenheimer & Co.

"It's all anyone wants to talk about," Schwartz said of conversations he has had with his clients over the past two months.

While Democratic presidential nominee Joe Biden has a clear lead in nationwide polls of voting intention, the margins are tight in the most important swing states needed to win the electoral college, making any outcome — from a second term for President Donald Trump to victory for Biden and a sweep of both houses of Congress for the Democrats — still in play. A delayed result or disputed outcome could lead to market volatility or even a big drop for assets sensitive to risk appetite, such as equities.

Schwartz has been advocating buying S&P 500 index puts to offset potential losses in equity markets caused by the election. "The strategy is designed to limit downside risk while still allowing room for upside appreciation without disturbing the portfolio," Schwartz wrote in an Oct. 14 note to clients. "The profit potential of the portfolio is reduced only by the cost of the puts."

With the outcomes and possible market reactions so murky, many investors have remained on the sidelines, waiting for the election to run its course, said Michael de Pass, global head of U.S. bond trading with Citadel Securities. He said the election has caused "more reticence among market players" and "reduced risk appetite" due to the potential for a drawn-out, contested conclusion.

Scott DiMaggio, director of global fixed income at AllianceBernstein, said investors are hedging less through government bonds due to low yields fueled by Federal Reserve policies. Some, he said, are likely looking at hedging through shorting commodity or emerging market currencies, which tend to be correlated with stock markets, in case of a bearish outcome following the Nov. 3 election.

"You need to have some balance in your portfolio, you need to have some defensiveness, because it's probably not smooth sailing from here to the finish line," he said.

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Lessons from 2000

If the result of the election is uncertain for a long time, it could hurt equities. The S&P 500 fell by nearly 11.7% from the Nov. 7, 2000, election day to Dec. 20, 2000, as a recount — and a legal fight over it — dragged on. The index was still down 6.2% from Election Day at George W. Bush's inauguration on Jan. 20, 2001.

Structuring a hedge is complicated by the difficulty in even knowing how the market might react to one scenario or another. A sweeping win by Democrats in the Nov. 3 has been viewed by analysts as largely bearish for U.S. stocks due to Biden's plans to impose higher corporate taxes. However, any decline in equities could be at least partially offset by fiscal stimulus efforts Democrats are expected to pursue in 2021.

"Getting the election right is a very difficult thing, and even if you could do that with 100% certainty, your chances of getting the market right are also very low," DiMaggio said.

Pandemic concerns

Still, there is debate over just how much of a market impact the election ultimately could have. The ongoing pandemic, analysts said, will likely bear far more weight on the future path of markets.

"The vaccine represents a more important factor than the election result for the recovery in S&P 500 fundamentals," David Kostin, chief U.S. equity strategist for Goldman Sachs, wrote in an Oct. 9 note.

"Covid matters more than the election," DiMaggio said. "Even if Biden wins, he’s not waving a magic wand in December and everything gets fixed."

According to an analysis of data by iVest+, a stock and options trading platform, options trading for all stocks on the S&P 500 has skewed far more dramatically bearish into 2021 than it has in the lead up to the Nov. 3 election. This signals that investors are far more concerned about the potential impact the coronavirus pandemic will have on stocks into 2021, rather than the impact of the U.S. presidential election.

Put activity for options expiring in 2021, well after the impacts of the Nov. 3 election are likely to be felt, is significantly higher than later into 2020, signaling a more bearish view of the market into next year.

The put/call open interest ratio for S&P 500 stock options expiring ahead of the election is about 0.55, which means that about 35.7% of open interest for these options expiring on Oct. 30 is for puts. If there were concerns about the impact of the election on equities that number would be higher, according to Rance Masheck, CEO of iVest+.

Wave two worries

For options expiring post-election in December, however, the put/call open interest ratio for these stocks jumps to nearly 0.80, or a roughly 44.4% of open interest for puts, the data shows. S&P 500 stock options expiring into 2021 have seen an average put/call open interest ratio of nearly 0.85, or about 45.9% of open interest for puts.

"The market doesn’t so much care about the election, but they do care about wave two of Covid," Masheck said in an interview. "There seems to be a lot of either betting on the downside or protecting for the downside happening forward into 2021."

Open interest is a measure of the total number of active options contracts and is different from trading volume, which is a relative measure of the options being actively traded during a given time.

The equity put/call ratio, which measures trading volume, was 0.50 on October 21, up from 0.47 a week earlier, according to the Chicago Board Options Exchange.