Monday, June 1st, 2020

Trading Options on a Government Shutdown


Times when the stock market is volatile are commonly good times for stock options trading. Now as political infighting in Washington drives us closer to a government shutdown the markets are volatile. Buying puts or calls on stocks may be quite profitable. The rationale for trading options on a government shutdown is that no one is really sure how long a shutdown would last. The amount of damage to the economy is measurable if things are settled in a couple of weeks. But, if congress cannot come to agreement on a budget and on increasing the debt ceiling the economy could be damaged. Remember that we are still feeling the effects of the worst recession in seventy-five years. According to economists shutting down the government will reduce GDP by half a percent per month for up to a month. If it goes on longer things will get worse. What is the best style of options trading in this situation? The good parts of trading options on a government shutdown are that a trader can limit any losses to the price of an options contract while leveraging his trading capital.

What Does Experience Tell about Trading Options on a Government Shutdown?

Nearly twenty years ago the US government shut down for two weeks. The stock market (S&P 500) fell four percent but jumped up ten percent when a deal was made to resume operations as normal. When debt default loomed in 2001 the market fell fifteen percent but made up the losses over the next six months. For the options trader timing is important. For those who would like to profit from the market turbulence and trade options on a government shutdown a long straddle could be an ideal strategy.

Allowing for Both Possibilities and Picking Strategies

The current impasse on Capitol Hill may be temporary or it may be the beginning of long term dysfunctional government. Using a long straddle we can profit from either up or down movement of the market. Trading LEAPS options we can account for a slower evolution of market trends when trading options on a government shutdown. Another way to approach this is to look at the short and long term damage to the US dollar if the government cannot settle on a budget or increase the debt ceiling to stay solvent. Forex options trading on the US dollar goes by the same principles as stock options trading. Forex options trading is the use of options in trading foreign currencies. A trader can sell or buy his dollars with Yen, Euros, British Pounds, or whatever currency is paired with the dollar in an options contract. If the dollar is going to suffer at the hand of congress traders will short the USD in favor of the Yen or Swiss franc. If they believe that things will get resolved shortly they will buy dollars. Likewise those who want to trade options on a government shutdown will buy puts or calls on the dollar with the foreign currency of their choice and await profits as the Capitol Hill Comedy unfolds.

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