The missing piece of the options puzzle after big news events

Your ballot and your brokerage account

One of the biggest mistakes I see investors make is allowing their political preferences to influence their investing decisions. Market expectations shouldn't be driven by your own personal ideology. As a Democrat this morning, it might feel natural to become bullish. As a Republican, it might feel the opposite. To be honest, neither response tells you much about corporate profits, valuations, or the price that you're paying for an investment. I'm not saying voting doesn't matter; it does. Vote according to your convictions and ideologies. Evaluate your investment decisions according to evidence.

A company's earnings don't automatically improve simply because one party wins. Profitable businesses don't suddenly become really bad investments because the other side takes control of Congress. That's not to say that policies can't affect individual companies and their revenues, expenses, and ultimately earnings. But it's important to make sure those decisions are based on facts, not opinions.

Why gridlock can appeal to investors

Divided government can actually make sweeping legislation much harder to pass. For businesses that are making 5- and 10-year investment decisions involving capital infrastructure, less uncertainty about potential abrupt policy changes that oftentimes happen with consolidated government control actually makes planning easier. When a company doesn't have to worry about Washington getting anything done, it can actually

focus on its business instead of potential regulation. Now, I want to be careful here to say that I am not making a blanket prediction that all stocks must rise with a divided government. Congressional disagreements can complicate budgets, debt ceiling negotiations, and policy decisions regarding what has mattered the most over the last six months, and that is the stance in the Middle East and its impact on the worldwide oil market.

The options lesson: direction is only part of the trade

Typically, when a major event like an election has a lot of implied volatility associated with the uncertainty surrounding it, we have a tendency to get volatility crush once the outcome becomes known. The prices of options, which increase prior to the event, oftentimes drop drastically regardless of the directional move of the market. This happens to both call options and put options as the implied volatility portion of option pricing drops. Vega is the Greek that measures an option's sensitivity to that change.

Consider a call option with a delta of .5 and a vega of .15. If the stock rises 2 dollars, delta would suggest roughly a dollar of additional option value. If implied volatility simultaneously falls 5 percentage points, vega suggests approximately $0.75 of loss in that same option. The gain then is only $0.25, and that's before time decay and other potential effects. Now, these are simplified estimates, as the Greeks themselves change as market conditions change. However, this is an example of being correct about the directional movement of an underlying asset and the option delivering much less than expected in return. This is why I say that direction is only part of the trade. Make sure to match the strategy to the opportunity. If, for example, I'm considering a bullish trade after a major news event like the election, I want to make sure to look at the stock's outlook, the option premium, and the next potential catalyst. If I expect a bullish move with increasing implied volatility, a debit type of strategy, like simply a long option, might work best. If I'm expecting a more bullish move but also a drop in implied volatility, typically a credit spread might work better—say, a bull put spread, as an example. It's important, as always, to understand exit strategies with these different types of trades and how they fit into your individual portfolio.

What comes next?

The market will likely start to look forward to Friday's jobs report to immediately test whether or not the euphoria surrounding the post-election period will hold up. We are still in the middle of earnings season, and NVIDIA stands tall as the earnings event that everyone's looking for to continue to lead the market. Oh, and don't forget the Fed. Inflation data and the impact on interest rates likely will continue to play into the market forecast as

well going forward. Rather than assuming that Wednesday's reaction is going to establish the trend for the next several months, I'm going to be paying attention to whether the buying interest broadens, whether individual stocks can hold their gains, and whether options premiums adequately reflect the potential risks ahead.

» FUTURES «

While You Were Sleeping

What the overnight session can tell you before the opening bell

Wednesday morning’s rally gave investors plenty to celebrate, but the overnight futures session gave me a reason to stay cautious.

As election results started rolling in, stock-index futures swung through a wide trading range before turning sharply higher. By the time StoneX released its morning update, Dow futures were up roughly 2.2%, S&P 500 futures had gained 1.2%, and Nasdaq futures lagged behind with just a 0.4% advance.

My main concern is that investors might be jumping the gun by treating this rebound as an all-clear signal. An election can clear up the uncertainty of who controls Congress, but it can't resolve the bigger picture issues like inflation, borrowing costs, corporate profits, or stretched valuations. Those underlying economic factors still have to work their way through the market.

The Nasdaq’s smaller gain also caught my eye. While a single morning’s divergence doesn't automatically mean a bearish trend is forming, it does mean I want to see stronger confirmation before I trust the broader rally.

For futures traders, an overnight bounce is a reason to take another look at downside exposure before the regular stock market opens. CME’s equity-index futures trade nearly around the clock during the workweek, so some traders use that window to see how overnight sentiment is shifting. Some market participants use short index futures positions to offset losses in a stock portfolio. How well that works depends heavily on the portfolio’s size and specific makeup, and it isn’t right for everyone.

Naturally, playing defense comes with its own set of risks. If stocks keep climbing, a short futures position will lose money and eat into your portfolio's gains.

This is where position sizing becomes critical. A Micro E-mini S&P 500 contract moves $5 for every index point. For example, a 50-point drop would generate a $250 gain on one short contract before fees, while a 50-point jump would mean an equal loss. It's also vital to remember that margin is just a deposit, not the maximum amount of money you have at risk.

Ultimately, my instinct is to treat this post-election rally with plenty of caution. I want to see this buying pressure hold up over the next few sessions before assuming the overnight reversal is a lasting move upward. Futures are one way traders can respond to overnight moves before the opening bell. After a volatile session like this one, it’s a good time to understand how that works, and what it can cost when the market moves the other way.