Option Strategies for 2024 Elections

2024 is a transitional year for political cycles in many countries and regions, with elections taking place across Europe, the US and India. The first week of July started with landmark elections in two major economies, the UK and France. The UK election resulted in a widely expected landslide victory for Kier Starmer’s Labour party. In France, on the other hand, the second-round election for the National Assembly resulted in a surprising turn from the first round, delivering what looks like a hung parliament, with the left-wing alliance Nouveau Front Populaire (NFP) winning 182 of the 577 seats, followed by Macron’s centrist coalition winning 168 seats.

Markets seemed to react more favorably to the French election results, with the Cboe France 40 Index rising over 1% in its first two hours of trading on Monday 8 July, the morning after the French election, likely reflecting relief that no single party secured a majority as was widely expected. By contrast, the Cboe UK 100 Index traded roughly flat through the UK election, likely because the results of the UK election were much closer to expectations.

In this article, we consider two option strategies for traders looking to profit from a specific view of how these elections might impact a fictional French stock: Le Boulanger Paresseux SA, with the ticker “LBP”.  We will assume that LBP is currently trading at exactly €100 per share, and no dividends are expected to be paid between now and option expiry, and that the trader expects LBP to trade sideways over the next several months, neither rising nor falling significantly. In other words, the goal here will be to try and profit from gridlock between buyers or sellers, where the trader makes money even if the stock doesn’t go up or down. Each of these strategies involve combining multiple options and show how targeted you can get with your options strategy both on the upside and the downside.

Strategy #1: The Butterfly

The first strategy we will consider is called a “butterfly”, so named because of the profit and loss chart might be compared to a picture of a butterfly flapping its wings. Here, the trader needs to choose an expiration date, and then a price expected to be the most likely level at which LBP can be expected to close on that expiration date. This strategy earns a maximum profit if LBP happens to close at exactly that target price on the exact expiration date, with gradually reduced payouts the further away the stock finishes from this target until the maximum loss of the whole premium paid for this option strategy. As an example based on LBP’s initial price of €100 per share, we put together the butterfly with the following three option positions:

1.   We buy one 90 strike call, and

2.   We selling two 100 strike calls, and

3.   We buy one 110 strike call

This option combination could also be seen as a pair of call spreads: we buy a 90-100 call spread, and then we sell a 100-110 call spread. Based on a few similar examples, we assume the total net cost of these three options to be around 3.50 per share, or a total of €350 per round lot of 100 shares of LBP. The sum of the payouts of these options at expiry, based on the final closing price of LBP on that expiry date, would be as follows:

A.  If LBP finishes below 90, all three options expire worthless and the trader loses the €350 premium, or

B.  If LBP finishes between 90 and 100, the long 90 strike call option pays out €100 per point that LBP finishes above 90, and the 100 and 110 strike calls both expire worthless. For example, if LBP finishes at 92, the option pays out €200, which would be a net loss of €150 versus the €350 paid for the option position, while if LBP finishes at 98, the option payout would be €800, or a €450 gain over what was paid for the option. The maximum payout of this option position would be €1,000, in the case that LBP finishes at exactly 100, or

C.  If LBP finishes between 100 and 110, then the short position in the 2x 100 strike calls would start eating into the payoff value of the 1x 90 strike option we are long. For example, if LBP finishes at 108, then the long 90 strike call would be worth €1,800, but the short 2x 100 strike options would require paying back 2x€800 = €1,600 for a net payout of €200, which would be a net loss of €150 versus the €350 paid for the option position. On the other hand, if LBP finishes at 102, the net option payout would add up to €800, or a €450 gain over what was paid for the option, or

D.  If LBP finishes above 110, then the gains from the long 90 strike option would be exactly cancelled out by the other three options, leaving a net loss of the €350 up-front premium paid of this option combination.

The net profit and loss of this strategy, based on the final price of LBP, is charted in this next diagram which is described as the “butterfly”:

Overall, this strategy makes the most sense for a trader who expects LBP to finish the term of these options within the “breakeven” range of 93.5 to 106.5, the range within which the final value of the options is worth more than the €350 premium paid up-front for the options. Of course, traders who instead expect that LBP will NOT finish within this range might consider putting on the opposite trade, where the €350 premium would be received up front and kept if LBP finishes below 90 or above 110, with the risk of having to pay out as much as €1,000 if LBP finishes at exactly 100. One disadvantage some traders see in this strategy is that the maximum payout is concentrated at a single point, and so a related strategy called the “Iron Condor” spreads out this maximum payout over a wider range.

Strategy #2: An “Iron Condor”

 The second strategy we will illustrate here is one whose name also conjures up images of a creature flying with wings, is called the “Iron Condor”, and differs from the butterfly primarily in spreading out the maximum payoff from a single point to a range. Although this requires putting together four distinct options contracts, all four of these options have the same expiry date, and are related in ways that make their overall exposure quite easy to understand, as we will see later:

1.   We buy one 90 strike call, and

2.   We sell one 95 strike call, and

3.   We sell one 105 strike call, and

4.   We buy one 110 strike call

 As with the butterfly, this can also be seen as a pair of call spreads: we buy a 90-95 call spread, and then we sell a 105-110 call spread, with the difference from the butterfly being the gap between the two call spreads. Based on a few similar examples, we can assume the total net cost of these four options to be around 2.25 per share, or a total of €225 per round lot of 100 LBP shares. The sum of the payouts of these options at expiry, based on the final closing price of LBP on that expiry date, would be as follows:

A.  If LBP finishes below 90, all four options expire worthless and the trader loses the €225 premium, or

B.  If LBP finishes between 90 and 95, the long 90 strike call option pays out €100 per point that LBP finishes above 90, and the 95, 105 and 110 strike calls all expire worthless. For example, if LBP finishes at 92, the option pays out €200, which would be a net loss of €25 versus the €225 paid for the option position, while if LBP finishes at 94, the option payout would be €400, or a €175 gain over what was paid for the option, or

C.  If LBP finishes between 95 and 105, then the lower 90-95 call spread pays it its maximum €500 value, while the upper 105-110 call spread expires worthless. This is the maximum profit of this strategy, where the €500 represents a net gain of €275 over the €225 premium paid, or 

D.  If LBP finishes between 105 and 110, then the short position in the 105 strike call would start eating into the payoff value of the long 90-95 call spread. For example, if LBP finishes at 106, the total final value of the options would be €400, versus  €100 if LBP finishes at 109, representing a net profit of €175 or net loss of €125 respectively, or

E.  If LBP finishes above 110, then the gains from the long 90-95 call spread would be exactly offset by the loss from the 105-110 call spread, leaving a net loss of the €225 up-front premium paid of this option combination.

The profit vs loss on this strategy, based on the final price of LBP, is charted below:

In other words, although this strategy does require trading four distinct options contracts, the Iron Condor does have the advantage of having a lower up-front premium and a wider range of maximum payout outcomes than the butterfly. As with the butterfly, a trader expecting LBP to finish outside this range may also consider taking the opposite position, where the €225 premium is received up front in exchange for taking the risk of having to payout €500 if LBP finishes between 95 and 105.

Conclusions

Even if you expect political gridlock to result in market gridlock, where stocks trade sideways with no clear trend up or down, the butterfly and iron condor strategies explained in this article are just two ways you can use options to more precisely target profits in your chosen range of outcomes. 

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Originally Posted July 18, 2024 – Option Strategies for 2024 Elections

Disclaimers

·The above is the product of external market analysis commissioned on behalf of Cboe Europe B.V. The views expressed herein are those of the author and do not necessarily reflect the views of Cboe Europe B.V., Cboe Global Markets, Inc. or any of its affiliates (‘Cboe’). For more information on how this research was conducted and/or the author please contact EUDerivatives@cboe.com

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·Hypothetical scenarios are provided for illustrative purposes only. The actual performance of financial products can differ significantly from the performance of a hypothetical scenario due to execution timing, market disruptions, lack of liquidity, brokerage expenses, transaction costs, tax consequences, and other considerations that may not be applicable to the hypothetical scenario.

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