No Debate, Buying Volatility Is Way To Play Tight Clinton-Trump Race

As the nation turns its eyes to Hempstead, Long Island and tonight's presidential debate on the campus of Hofstra University, one thing remains clear: stocks are overvalued.  Also, the volatility being priced into stock prices is strongly undervalued, in my opinion.  

Regardless of whether Trump or Clinton scores the most points tonight and is declared the winner (by the pundits, anyway) the tightness of the current polls suggests a very close election. That implies to me the rhetoric will intensify, and the market should be afraid of politically-charged October surprises.But it is not. Why? 

Fed Chair Janet Yellen gave the Street exactly what it wanted last week with the no-change vote on the Fed Funds rate and somehow --and she's quite skilled at this--managed to telegraph a December rate hike and still sound very dovish. So, the mini-spike in volatility that had occurred in the first few weeks of September dissipated and the CBOE’s VIX index once again sits near 12, an extremely low level by historical standards.

At the same time the earnings erosion in Corporate America continues at an alarming, if oft-overlooked pace. Did you know that the current quarter will represent the sixth consecutive quarterly decline in S & P 500 profits? FactSet’s consensus calls for a 2.3% decline in third quarter earnings for the S & P.  The “E” is shrinking, but the “P” remains near all-time highs and no amount of Fed-worshipping can justify that math.

So, we’re overdue for a correction, and the timing is perfect to imitate a long position in volatility. It’s low, and we were all taught to buy low and sell high, weren't we?  

Here are three ways to buy volatility, which essentially protects your portfolio in case of a quick downdraft.  These trades also offer upside in a market that I believe--regardless of who wins the debate--is  running out of gas and has almost no upside, but plenty of downside risk, at 2160 on the S&P 500.

1. Buy call options on the VIX index. I’m seeing October calls on the VIX (which expire October 19th) quoted at $3.03 for the 13 strike price and $2.80 for the 14 strike. In two trading days 9/9 and 9/12 the VIX went from under 12 to over 20.  That type of short, sharp spike in the VIX is not uncommon, and would prove very lucrative if it happens again and you own those options contracts.
2. Buy VIX-based ETNs. The most common of these are VXX and TVIX, and, frankly, I hate them all, but this is a time to hold one's nose and buy them.  The volatility ETNs have to rebalanced every day, and thus can mask changes in underlying indices, but if we have a quick pullback they will rise and you will generate a very healthy trading profit.  Also, these ETNs trade just like stocks, so you don't have to deal with the high commissions and arcane internal formulae options contracts possess.
3. If you want a stock pick for a period of increasing volatility, it's sensible to focus on the exchanges themselves. CME Group , Nasdaq OMX, CBOE Group and Intercontinental Exchange (which owns the NYSE) are names that jump to mind.  The exchanges have been consolidating rapidly--as evidenced by today’s announcement that CBOE Group is buying the BATS exchange--and would benefit from an increase in trading volumes that accompanies increased volatility.