2024 US election-driven volatility and trading opportunities explained

Election-induced market dynamics

Following the recent interest rate shift in the United States (US), one of the most significant events of this year is approaching in early November: the US presidential election. While political impacts may be short-lived in other countries, the influence of the election outcome across the Atlantic on Wall Street is substantial.

Ultimately, the US election is likely to receive considerable attention worldwide. For traders, volatility is particularly intriguing. It's not only elevated in election years but is likely to increase sharply just before the election.

Investors dislike risk

Volatility is often referred to as the "fear index," and for good reason. As historical volatility rises, so does market risk, and as is well known, investors don't favour this. The relationship between the volatility index (VIX) and the S&P 500 is clearly visible in the first graph. As volatility increases, Wall Street declines and vice versa. Recently, volatility has been slightly declining.

Inverse relationship between S&P 500 and VIX volatility index

Correlation insights: S&P and VIX

The dependency between the S&P price trajectory and volatility can also be mathematically determined using correlation. This statistical measure indicates the extent to which data series A (volatility) influences data series B (S&P). In the case of volatility, there is historically a so-called inverse correlation.

As volatility rises, prices on the New York Stock Exchange fall, and vice versa. The second chart shows the correlation between the S&P and the VIX over the last twelve months, as well as the correlation of the past thirty days. On average (median), the measure is -0.79. Such high values are considered statistically significant, suggesting that a significant change in volatility will have a major impact on Wall Street activity.

30-day rolling correlation between S&P 500 and VIX

Volatility rises before the election

Let's now turn to the possible course of volatility immediately before and after the US presidential election. The historical volatility range and the broad-market US index show a high inverse correlation, which could work to investors' advantage.

Shortly before the election, on 29 October, a weak market phase begins for the VIX, which could last until 25 December. During this period, volatility loses significant momentum, to the benefit of the US stock market. In the past ten years, the S&P has been able to gain an average of more than 3% in 75% of cases.

Seasonality of the S&P 500 and VIX in the past nine election years

Risk management is key

In election years, volatility is highest compared to other years of the US election cycle. Especially shortly before and after the election, increased volatility in the stock market must be expected. Traders can use this knowledge by:

• Profiting from the inverse correlation between the VIX and the S&P. In this case, a short position could be opened on the VIX and a long position on the S&P
• Hedging their existing portfolio. With short positions, investors could prepare for a surprise on election day. A prime example of this was the 2016 election
• To the general surprise, Donald Trump emerged as the winner. The DAX 40, for example, was down more than 500 points in pre-market trading on this memorable day. At the end of the trading day, the German benchmark index closed up around 250 points.