Everybody likes a good forward on an esoteric backtest.

For what it’s worth, at least some market participants are playing for the by-now well-socialized, post-election vol bleeder in the US.

Headed into Tuesday’s vote, VIX downside was bid in some corners, indicative of folks coming around to the election “seasonal” (that’s a bit of a misnomer, but you get the idea) illustrated in the figures below, from Nomura’s Charlie McElligott.

I highlighted those charts a few days back. McElligott updated them for Election Eve, and there’s an extra one in there: The correlation election analogue.

Those are pretty compelling. It’s (almost) surely the case that past will be precedent in terms of the vol crush illustrated above in a “Harris-Gridlock” scenario. That’s the “best” outcome if you’re playing for a hedge bleed-out that sees equity downside move OTM as the event risk clears and markets rally on the combination of a “safe” (i.e., establishment) president handcuffed on fiscal policy by a recalcitrant GOP-controlled House/Senate.

The figure on the left below shows the result, on the dealer side, of VIX downside demand from clients. Dealers are now “outright net short VIX puts to end-users,” McElligott noted. The tables on the right show the backtest when VIX dealers are net short puts.

The implication’s clear: When end users (i.e., clients) place enough bets on lower implied vol to flip market makers net short VIX puts, the forwards do indeed point to lower vol and, not surprisingly, higher stocks.

Of course, in 2024, that outcome’s probably contingent on some kind of divided government. As Charlie went on to say, a sweep scenario for either color (i.e., red and certainly blue) would wrong-foot markets at this juncture, likely triggering a rates shock of the bear-steepener variety. And as I’m always fond of reminding readers, the worst kind of rates shock is an aggressive bear-steepener predicated on fiscal profligacy concerns or worries about the currency. The latter (i.e., currency worries) doesn’t generally apply to America, but the US long-end is certainly vulnerable to the former (i.e., vulnerable to escalating worries about fiscal recklessness).

There’s probably no point in saying this given how far-fetched it is in the US context, but just in case: A disorderly bear-steepener — i.e., a scenario in which a country loses control of its own long-end — is the nightmare outcome. That’s what you see in emerging markets, and it’s what you saw in September and October of 2022 in the UK. I’d say “that can’t happen here,” but if that other thing that’s not supposed to happen here does happen (here), anything’s possible. In simple terms: If Trump wins, he has to (has to, has to) govern as a democrat, small “d,” or he’s courting disaster.

Coming quickly back to the dealer positioning on the VIX puts, McElligott summed it up. “[W]e backtested when ‘VIX Options Dealer Positioning in Puts = Net Negative,’ and the median moves in UX1 / VIX then signal big time ‘vol crush’ thereafter across nearly all time horizons.”