Impact of Economic and Political Events on Options Trading

The impact of economic and political events on options trading and nsights into the strategies and tools that traders can use to navigate the market. It also highlights the potential risks and challenges involved in options trading during unpredictable events.

Options trading is a popular investment strategy that allows traders to buy and sell options contracts, which give the holder the right, but not the obligation, to buy or sell an underlying asset at a specific price on or before a particular date. The value of options contracts is affected by a variety of factors, including economic and political events. 

This article will provide an overview of the critical economic and political events that affect options trading and the strategies and tools that traders can use to navigate the market. Whether you’re a seasoned options trader or just starting out, this article will provide valuable insights into the world of options trading and the role that economic and political events play in it.

What can impact the markets?

Political and Economic Impacts on Markets

Company-specific Impacts

• New labour agreement
• New CEO
• sale of inventory
• Wage payment

The Indian political system is democratically elected, and various decisions are taken at different times that impact the environment of the country. Political reasons are multifaceted and may include

• Policy decisions and shifts affecting things like trade tariffs, taxes, labour conditions, privatisation and regulation
• Political leadership changes and government instability
• Political volatility and uncertainty stemming from terrorism, riots, coups or war

Similarly, if we explore economic events in the country, a few examples may be

• RBI’s new chairman election with a different outlook towards monetary and fiscal policies
• Passage of new financial bills such as GST, Bankruptcy law, NPA’s etc
• The arrival of new policies to boost the economy, such as infrastructural or logistics policies
• Amendments in regulatory frameworks of banking, financial sectors and more

Not only this, there are events that are company-specific, like the signing of a new labour agreement, the hiring of a new chief executive officer, the sale of an item of inventory, or simply the payment of monthly wages, which may be equally relevant for investors. Those looking at a company’s financial status (shareholders, investors, creditors, managers, auditors, etc.) need to be able to assess the financial impact of all such events before making investment decisions.

How are options impacted?

The reasons stated above affect any region’s social, political and economic fabric. And as far as the financial markets are concerned, volatility and buyers’ trust are hampered the most when things go awry. So, where does options trading stand in this case?

We avail options trading considering its excellent upside potential with losses limited only to the option’s premium, so it is a good source of risk hedging. However, even with such good qualities, options trading is not immune to unpredictable political or economic events. Additionally, options trading does have drawbacks to consider as its value is subject to the underlying asset, plus the offer is limited for a particular period. The main disadvantage of options contracts is that they are complex and difficult to price. This is why options are often considered a more advanced investment vehicle, suitable only for experienced investors.

Unanticipated Events

Despite measuring all pros and cons, the moment we decide to jump into trading after a thorough analysis of political and economic forces at work, we may confront unanticipated avoidable or unavoidable risks, especially in options trading. Firstly, the financial market relies on anticipation of events. For example, a company XYZ may win the contract of being an official sponsor of IPL. This company may attract multiple investors in anticipation of expanding options premium and high ROI. If it doesn’t go as planned, options will expire worthless if the stock does not move enough to be in the money. However, you must be accurate with option valuations and precise in your timing when you are trading based on such events.

Market Volatility

The other impact that merits our attention is volatility. It is again an important aspect which causes option valuation to change. For example, let’s say RBI, in its revised monetary policy, will cut the benchmark rates. What is sometimes ignored is the fair value of an option strike based on the volatility curve triggered ahead of the event or after. In this digital era, we don’t have to wait till then as the market either spikes up or plunges moments before the news is flashed. The question is – can option traders capture this sharp move before the result is out? The trick lies in understanding the fair value of an option strike by using terminal volatility to find out the volatility-adjusted market movement. 

Price Movement

Another fact that you cannot ignore is the movement of prices, i.e., inflation or deflation, which can work hard against you, especially during political or economic turmoil. For example, a change in a country’s tax structure, minimum wage or regulatory requirements could raise costs and, depending on a company’s ability to pass those higher costs on to consumers, have an unanticipated impact on earnings. Such shifts can disrupt a company’s ability to execute strategy and deliver products or services. In turn, this can affect company performance and profitability, thereby reducing the value of underlying assets of its options trading, boosting the market capture for only a few people who share proximity with the government. The establishment of a fair market, in this case, is of prime importance.

To Summarise,

It is evident that financial markets abhor political and economic instability. Nevertheless, it is an undeniable and unpredictable part of trading. The trick lies in being cautious and taking well-calculated risks to get through trying times.