This commentary originally appeared on Real Money Pro on Oct. 27. Click here to learn about this dynamic market information service for active traders.
As we head into what could be one of the most volatile elections of our lifetime the financial markets are trading eerily quiet. It is clear market participants are comfortable with the odds of a Hillary Clinton victory, which shouldn't lead to many policy changes or surprises. However, there are always surprises when it comes to politicians (particularly this time around).
That said, we aren't so sure the so-called favored candidate is going to win, and even if she does there could be some fireworks going into election night. Accordingly, we like the idea of getting prepared for a potential wave of risk-off trades. In our opinion, the best way to proceed is with the purchase of what seem to be highly discounted call options in the Treasury market.
We were surprised to find that implied volatility in the 10-year Note options on futures is at the lowest level seen since 2007 (see chart below). For those that aren't familiar with option mechanics, implied volatility is the amount of additional premium built into options pricing to account for expectations of market volatility.
When implied volatility is high, options are over-priced in anticipation of big price swings, when it is low the market is assuming volatility will remain low. In short, options are expensive during times of high implied volatility and they are cheap in times of low volatility.
With this in mind, this is the cheapest time to buy Treasury calls in nearly a decade.
An environment of cheap options is enough to justify purchasing calls in Treasuries, a market that is traditionally more explosive on the upside than it is the downside. Yet, there is even more compelling evidence to suggest it might be worthwhile to buy a ticket to the show just to see what happens.
For starters, 10-year note futures often show strength during the winter months so seasonal tendencies are supportive. Further, the chart looks promising.
The relative strength index (RSI) has fallen into the low 30s and the William's %R is under 10 -- each of these are often pre-cursors to a trend reversal. This occasion is particularly attractive because the indicators are becoming saturated as prices are testing trend-line support. While we cannot rule out a temporary breach of support to test the high $129s in the 10-year note, it looks like the downside is limited.
We like the idea of shopping for underpriced call options written against the December 10-year note futures contract. We particularly like the December 130.50 calls, which are going for about $220 (this amount represents the total risk per contract before transaction costs).
After all, the election could spark market volatility. If not, we are only out a small amount of money.