JPMorgan's Josh Younger on Rate Derivatives and Volatility Ahead of the Election

Tracy Alloway (0:10)

Hello, and welcome to another episode of the Odd Lots Podcast. I'm Tracy Alloway.

Joe Weisenthal (0:16)

And I'm Joe Weisenthal.

Tracy Alloway (0:18)

Joe, we have been watching The Vix, haven't we?

Joe Weisenthal (0:24)

We have. I mean, it's been, we've had a lot of episodes this year for pretty obvious reasons, looking at The Vix, exploring volatility, what signal is embedded in it, what it tells you, what it doesn't. But people love hearing about The Vix, so I'm always up to talk about it.

Tracy Alloway (0:44)

You know, as I said that sentence, I kind of realized what a weak intro it was, and I need to work on, put more thought into how I start these things. But yes, okay.

Joe Weisenthal (0:53)

No, it's fine, it's fine.

Tracy Alloway (0:55)

We talk a lot about volatility. We talk a lot about the market structure of volatility. But lately, we've been talking about volatility more in the short term, in the sense that we have this really big potential tail risk on the horizon in the form of the US elections. And if you look at the VIX, even though it's relatively low, if you look at the actual term structure or the curve of the VIX, you can see it's quite, well, it's not as elevated as it was a few weeks or months ago, but it's still elevated compared to normal right around the time of the elections and for a few weeks after that. So that's a bunch of people pricing in the risk of something unexpected happening in the US elections.

Joe Weisenthal (1:42)

Yeah, absolutely. I mean, this has been building for a while. I should note we are recording this Tuesday, October 20th. So we are literally two weeks away from November 3rd election day. Although by the time you hear this, I think based on when we expect to release it, it's gonna be about a week. But yeah, you're absolutely correct, which is that for several weeks or months now, the volatility term structure has been super bit up, not just at the beginning of November, but for a long period as the risk of a long drawn out count is a possibility.

Some of that has come in a little bit, less concerns about that as the polls have widened between the two.

I mean, I guess there's always sort of gonna be some expected volatility around election. But the clear thing is because of so much going on and all the uncertainty and economic situation, there is a lot of anxiety and uncertainty about the election and its ramifications.

Tracy Alloway (2:41)

Yeah, it kind of, for me, it brings to mind three questions. So number one, are markets pricing in the results of the US election correctly? So are the polls right this time versus what we saw in 2016? And secondly, our investors, we've discussed this before with Crissidial most recently, but are investors so well hedged now around the election that it's going to be really tough to actually spark a volatility event? Or third, are we mistaking that volatility premium and is it in fact market complacency? Should investors be more worried? So those are all sort of interconnected questions, but we're gonna be discussing them with an Odd Lots favorite on this episode. I think this is going to be his third appearance on Odd Lots. It's Josh Younger, Head of US Interest Rate Derivative Strategy over at JPMorgan Chase and he's been writing quite a lot about this.

Joe Weisenthal (3:43)

Three episodes, is that when you get the Odd Lots tote bag?

Tracy Alloway (3:47)

That's right. You get the sweatshirt.

Josh, we'll send that over to you after this episode. Welcome to the show again.

Josh Younger (3:53)

Yeah, thanks. It's great to be back.

Tracy Alloway (3:56)

So I guess just to begin, could you maybe lay the scene for us in terms of what we're seeing in market positioning on volatility? We spoke a little bit about how at one point it looked like markets were building in quite a big risk premium around the elections and beyond it.

You wrote about this, that it looked like investors were bracing possibly for a contested election, but we've seen that risk premium come down recently. What does that say about where the market actually is positioned?

Josh Younger (4:27)

Yeah, so maybe it's best to start by getting a sense of how we actually extract these numbers because it's sort of easy to say, well, the market's pricing X, Y or Z for the election, but ultimately we need to get this from some traded instrument and the price of that instrument. And with options markets, the price of the option is proportional to or related to the potential for large moves. So that insurance is worth more if the likelihood of a large move is greater. And so you have to pay up for that insurance and vice versa if you think the likelihood of large moves is lesser. And so what we do is we take options that expire after the election and we compare the price of those options, adjusting for the extra time value of them to the price of options that expire before the election.