NEW YORK (Reuters) – A surprise result in Tuesday’s U.S. midterm elections could unsettle markets poised for relative calm, options strategists said. Control of the US Congress is at stake in Tuesday’s midterms, with Republicans favored by polls and betting markets to win control of the House of Representatives and possibly the Senate. With Democrat Joe Biden in the White House, that potential outcome would lead to a divided government, an outcome generally seen as favorable for markets over the long term. But a surprise Democratic victory could send markets into a tailspin, potentially bringing to the fore concerns about tech regulation as well as budget spending that could boost already high inflation, according to market players . Analysts said a calendar packed with closely watched macroeconomic events, such as last week’s Federal Reserve meeting and U.S. consumer price data later this week, left traders less focused on the vote than usual. With investors’ election hedging relatively light, “any surprises will likely be exacerbated by the weak markets and relatively high volatility landscape we’re looking at right now,” said Chris Murphy, chief derivatives strategist at Susquehanna International Group. Options placement suggests a 1.5 percent drop in the S&P 500 the day after the vote if Democrats put in a stronger-than-expected showing, according to Tom Borgen-Davis, head of equity research at options brokerage Optiver. “A big Democratic victory could be taken negatively for the tech sector, given that they are more likely to bring regulations in the sector than the Republicans,” Borgen-Davis said. That said, options traders don’t seem to be set for fireworks. For example, open positions in the Nasdaq 100-tracking PowerShares QQQ Trust, typically used for defensive positioning, outnumbered put calls, typically used for bullish bets, by 1.4 to 1, one of the narrowest margins since mid-June, according to the Trade Notification Data. The story continues Meanwhile, the Cboe Volatility Index, known as Wall Street’s fear gauge, fell on Monday to close at a near two-month low. The SPX rose 0.96% but is still down 20% for the year. (Graphic: Ebbing fear, https://fingfx.thomsonreuters.com/gfx/mkt/lbvggreoyvq/Pasted%20image%201667848468559.png) Morgan Stanley strategists, including Mike Wilson, wrote on Monday that a Democratic victory could raise Treasury yields and strengthen the dollar, reflecting the view that higher fiscal spending could worsen inflation and force the Fed to raise interest rates higher than expected. “Markets could assign a higher likelihood of further fiscal expansion, with Congress and the Fed pulling essentially opposite directions on inflation,” Morgan Stanley analysts wrote. On the other hand, a clean sweep by Republicans could increase the chances of a Republican spending freeze, boosting bonds and supporting the latest rally in U.S. stocks, which has soared this month, according to Morgan Stanley. At the individual stock level, some names have the potential for higher election-related volatility, Goldman Sachs strategists said in a note earlier this month. For example, revenue at iHeartMedia Inc Fox Corp, Paramount Global and Meta Platforms Inc could potentially get a short-term boost from ad-related spending around the midterm elections, according to the report. Meanwhile, shares of tobacco company Philip Morris International Inc could be volatile around regulatory restrictions, Goldman analysts wrote. (Reporting by Saqib Iqbal Ahmed in New York; Editing by Ira Iosebashvili and Matthew Lewis)
