The Best Trump Trade No One Expected

February 14, 2017

What's the best-performing trade since Donald Trump was elected president? Even today, with the benefit of hindsight, a lot of people might not know. Go back a few months to November, or even earlier, and no one in their right mind would have predicted it.

As surprising as it sounds, a bet on declining volatility is the top trade since the elections and of 2017 so far.

That's astonishing, because, if anything, most analysts were calling for just the opposite―a rise in volatility from the uncertainty that a Trump administration brings. His unpredictable policies, especially when it comes to trade, would inevitably lead to large fluctuations in the stock market, they argued.

Perhaps those prognostications will eventually come true. But as a recent Bloomberg article points out, volatility has been below average for the past five years; it will take a much more significant spike in stock market fluctuations before those calling for higher volatility are proven correct.

Lowest VIX In A Decade

In the meantime, the CBOE Volatility Index―a measure of implied volatility based on S&P 500 options―continues to fall. The VIX, as it's commonly known, briefly dropped below 10 for the first time in a decade earlier this month.

Of course, that won't last. A market sell-off and at least a temporary increase in volatility are inevitable. The VIX is mean-reverting, something that's clearly reflected in the futures curve for the index. For example, VIX futures for the month of October were last trading at 18.5, much higher than "spot" VIX or the front-month February contract (a situation known as contango).

As spot VIX and front-month VIX contracts dropped by 42% and 27%, respectively, since the elections, longer-dated contracts fell by much less. This has resulted in a steepening of the VIX futures curve.

Source: Bloomberg

That's been money in the bank for anyone betting on falling volatility, including holders of inverse VIX exchange-traded products. A strategy of shorting near-month VIX futures contracts has benefited both from the decline in the prices of those contracts and "roll yields" from the steep, upward-sloping futures curve.

 

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