The arrest of former President Donald Trump poses a major risk for the stock market.
The midsummer deadline for Congress to raise the debt ceiling could morph into a Republican attack on profligate Democratic spending, injecting extraordinary volatility into the global financial system. That could turn a prosaic vote into a battle royale over the nation’s extraordinary debt and tax-and-spending ways.
The details of the issue are less important than the sound bites. Already, prominent Republican politicians have criticized Trump’s prosecution as Democratic partisanship. They could return fire and even make government spending an issue.
Trump and some prominent Republicans have criticized his legal woes as political persecution by a Democratic district attorney, Manhattan’s Alvin Bragg. Trump, who is running again for president, has insisted that he has done nothing wrong. Bragg contends that Trump’s alleged hush-money payment to a porn actress, and related issues, constitutes a felony.
The potential market impact is high. Treasury Secretary Janet Yellen warned Congress in March that it would be “completely devastating” if the debt ceiling wasn’t raised. She mentioned grim repercussions for regional banks and the broader financial system. The government reached the spending limit in January. Yellen has used what she called “extraordinary measures” to provide funding that is expected to expire sometime this summer.
If the U.S. government can no longer pay its bills, the U.S. dollar’s position as the world’s reserve currency might be challenged by our enemies.
U.S. Treasury bonds, for instance, might no longer be considered the safest investment in the world. Other nations may decide that it isn’t prudent to rely on the U.S. dollar as their reserve currency for fear America’s financial system has been politicized. China has tried for years to compete with the U.S. in this area.
We recently suggested that the federal government was likely to develop ways to protect banks after the failures of Silicon Valley Bank and Signature Bank. So far, the stability of the
SPDR S&P Regional Banking
exchange-traded fund (ticker: KRE) has indicated as much. But it is difficult to ignore Yellen’s warning and the poisoned politics polarizing America. The regional banking sector is particularly vulnerable to a debt-ceiling logjam, given their large holdings of Treasury bonds.
Rather than getting caught up in politics, let us consider something that is reasonably concrete: options volatility. The
Cboe Volatility Index,
or VIX, is around 19, suggesting little fear about the stock market’s near-term trajectory. VIX futures, upon which VIX options are priced, are higher, which suggests investors are more worried about risks facing the market over the next seven months. (You can check VIX futures at www.vixcentral.com.)
To hedge the debt-ceiling vote, aggressive investors can consider buying a “put spread” on the SPDR S&P Regional Banking ETF, which entails buying a put option and selling another put with a lower strike price but a similar expiration. (Puts give a buyer the right to sell a particular asset at a set price and time.) The strategy will increase in value if the ETF declines.
With the ETF at $42.46, investors could buy the September $40 put and sell the September $30 put for about $2.20. If the ETF is at $30 at expiration, the spread is worth $7.80.
If the debt-ceiling issue is resolved and the ETF advances, the money spent on the put spread will be lost. But a resolution now seems elusive.
Steven M. Sears is the president and chief operating officer of Options Solutions, a specialized asset-management firm. Neither he nor the firm has a position in the options or underlying securities mentioned in this column.