Investors who are highly concerned about potential risks in the coming weeks may be caught off guard if the worst-case scenario does not materialize. The volatility of stocks, bonds, and currency options is on the rise as investors pay higher prices for protection. Risks are evident, such as the fiercely contested U.S. presidential election, interest rate decisions in the U.S. and Europe, the escalating threat of conflict in the Middle East, and the upcoming earnings season. In the stock market,Implied volatilityOption traders prefer put options to call options to hedge against selling pressure as volatility exceeds actual fluctuations.

Cross-asset strategist Charlie McElligott of Nomura Securities stated last week, "Due to a series of events occurring simultaneously, risk management departments are pushing buyers to overhedge." "Investors everywhere are fixated on the 'worst-case scenario' tail." He added that based on statistical data, when such overhedging occurs, the market always performs well, with the median stock market rising by 13% one year later.

Although various indices have reached record highs, the volatility shock in early August is still vivid. Market participants have not returned to the calm levels of the first half of this year, when hedge trades were seen as dragging down market performance. Overall trading is sluggish, some investors are even withdrawing funds: last week, the open interest value of Nasdaq 100 index futures decreased by $5.7 billion in a single day.

However, if the market withstands the test of the November events, generating only ripples and not a tsunami, traders may find themselves overprotected and underexposed, leading to another situation of chasing the uptrend.

The underperformance of hedge investment portfolios has started to show: since August 5, the Invesco S&P 500 Downside Hedged ETF has fallen by 1.1%, while the SPDR S&P 500 ETF Trust Fund has a total return of 13%. When protection is released or has just expired, the need to adjust the trading book will result in additional buying from the other side of the trade.

While the volatility index of the Cboe Global Markets and other options cost indicators are still at high levels, the one-month realized volatility of the S&P 500 index has dropped by over half since mid-August, approaching a three-month low. Lower figures, especially after the drastic volatility in early August is excluded from the calculation, will attract systematic investors back into the market, creating another driving force. Nomura Securities estimates that this group alone may buy around $160 billion of stocks in the next three months.

The wave of U.S. corporate buybacks is set to resume in less than two weeks, with billions of dollars worth of stocks being bought back daily, adding another bullish sentiment. According to announcements from previous years, Birinyi Associates estimates that over $1 trillion of buybacks will be completed in 2024 and 2025.

All of this could unfold in the final quarter of this year, when liquidity typically decreases and the market tends to rise.

There are signs that investors are starting to prepare for an end-of-year rally. In the past week or so, traders have purchased over 0.1 million units of December $615 SPDR S&P 500 ETF call options, which are currently trading more than 5% above the market.

Scott Rubner, Managing Director of Global Markets and strategy expert at Goldman Sachs, wrote in a report to clients last week: "The market sell-off has been canceled, with institutional investors now forced to enter the market, clients transitioning from left-tail hedging to right-tail hedging, and the end-of-year rebound is starting to resonate." He added that professional investors are increasingly concerned that they will significantly lag behind benchmarks.

Historically, from October 15th to the end of December, the median return rate for the S&P 500 index has been 5.2%. According to Goldman Sachs' data, in election years, this figure is only slightly higher at around 7%, implying a year-end level of 6,270 points. Bloomberg compiled data shows that in the nearly century-long history of this data, only 25 years saw negative returns in the fourth quarter of the stock market.

Although analysts expect a profit growth rate of only 4.3% in the third quarter, much lower than the previous quarters, the overall US earnings season usually starts positively, with most banks reporting performances better than expected. Thomas Hayes, Chairman of the investment firm Great Hill Capital, pointed out that the liquidity provided by the Federal Reserve has also been a strong support for the stock market.

Hayes said, "Will this be the first October of an election year with very limited volatility? Will we face the usual pre-election battering or just scrape through?"

Editor/rice