With the Presidential election in Brazil now less than a month away, I am starting to see a lot of upside call and call spread buying in the most actively traded Brazil etf (EWZ). Most of the activity has been taking place in the November 20th and December 18th expirations where the open interest in the calls with strikes between 40 and 50 is ~ 2mm in November and 750k in December. With the general election set to take place on Oct 4th, it seems a bit odd that the activity in both November and December has vastly outnumbered the volume in the October options, which only has a bit more than 300k of open interest for those same call strikes.
A closer look at how the election process in Brazil takes place likely explains why we are seeing a huge difference in the option activity in the later months over the month where the election is taking place. In Brazil, if no candidate gets more than 50% of the vote in the first election, there is a runoff shortly after between the top two candidates. Therefore, while the election is set for Oct 4th, the runoff election (if needed) will take place three weeks later on Oct 25th. The most recent polls show current President Lula with a five-point lead over Senator Flavio Bolsonaro. However, President Lula currently has less than a 40% share of the overall votes in the poll (38% to 33%). With the election only four weeks away, it seems rather unlikely that either of the top candidates will secure the 50% of the vote needed to avoid having the runoff election on Oct 25th.
While the betting markets are strongly saying there is likely to be a runoff election, I don’t believe the options markets are reflecting that as much. This can be seen when we overlay the charts of the September, October and November 40-delta call implied volatilities. While we can clearly see a large spread between September and October vols to reflect the election (29 vs 37), there is only about a 2-3 point difference between the implied vols in October and November (37 vs 39). Given what we know about the election, and the required 50% of the vote to win, I would argue that owning the runoff election November calls looks far more attractive than owning the October calls that only cover the first election (that is very unlikely to produce a winner).
November (green) upside call implied vol is only about 2-points more than the October (orange) implied vol
What is also of note is that current polls of a projected runoff between the top two candidates show an even narrower lead for President Lula (46% to 44%). The general belief is that a Flavio win is much more likely to produce a more favorable stock market reaction, especially if investors interpret it as a credible shift in fiscal policy. So not only would a runoff election mean that November upside structures are more likely to come into play versus any October call or call spread, but a runoff election is more likely to produce a winner that the stock market would be more receptive to.
With EWZ having rallied more than 13% from the mid-August lows (perhaps starting to reflect some of the possibility of a Flavio runoff win), and with the Oct/Nov vol spread only ~ 2-3 points wide, I really like the setup to own some lower-cost upside call calendar spreads. Again, it seems very unlikely that the Oct 4th election will produce a winner, so I want to own November market upside in case of a Flavio victory, and help offset some of the higher cost/vol by selling the “rich” October calls against it.
I would be targeting a breakout above the long-term resistance level of 42 on a potential Flavio runoff victory
Here is an EWZ October/November call calendar trade I would consider adding at this time:
Sell EWZ Oct 16th 42 calls
Buy EWZ Nov 20th 41 calls
Costs ~ $1.20 (EWZ Fri close ref 37.86)
Trade Details:
- Selling the higher strike (lower delta) October calls to buy the November higher delta calls
- November calls will capture the expected runoff election, while the October calls will expire well before that
- November vol is only ~ 2-3 points above October, I would argue it should be much more given current polling
- Selling the Oct calls will cover ~ 33% of the cost of owning the November calls
- Trade is long delta and positive theta to start
- Already seeing a lot more activity in the November (and December) calls – likely speaks to demand for the runoff election over the first election
- Can consider selling the upside November calls against the long Nov 41 calls after the October calls expire. This would further reduce the overall expenditure on the trade and still allow for upside
- Please reach out to me or the 22V sales team for updated pricing and execution capabilities
