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The Effect of Time on Trump’s Win Likelihood
Not everybody is an options trader, but during an election year there is at least one binary option that most of us care quite a bit about and that’s the option on the US Presidency. There are ways to trade the binary option, but my interest here is not in valuation.
People generally understand that if an option with a payoff of $1 or $0 (depending on the outcome of the event) is trading at $0.60, it means that the market is pricing a 60% chance that the event will occur. (Because 60% chance of $1 + 40% chance of $0 has an expected value, if we ignore discounting, of $0.60). But what I think many people don’t naturally understand is how the 60% chance changes over time even if nothing changes in the underlying circumstances.
If you’re not an options trader, this might be confusing. If Trump has a 60% chance of winning based on the current circumstances on July 31st, then if the exact same circumstances prevail on October 31st shouldn’t the odds of him winning still be 60% (and therefore, the price wouldn’t change)? The answer is nope, not at all.
Let’s suppose that we can summarize “the current circumstances” with one metric, that being the national polling margin.[1] Trump currently polls about 2 points ahead of Harris nationally according to the RealClearPolitics average. If that’s still true on November 5th, Trump will win (again, pretending that the winner of the popular vote automatically wins the election). The odds of him winning would be, of course, 100%. If he only drew 49% of the vote, his odds of winning would be 0%. That’s on the day of expiry, when the odds have to collapse to 100% or 0%.
Prior to the last day, time and volatility work in favor of the challenger and against the leader. If I am the leader, then I want nothing to change. Good things will help me, but won’t change the situation (I’m still expected to win), but bad things might change my expected win to an expected loss. The more volatility there is, the more crazy things happen, the more chances there are that my victory will turn to a loss. If I am behind, I want chaos, and the closer I get to ‘expiration’ the more I am willing to risk to get the chaos. Think about pulling the goalie in an elimination round in hockey or soccer…if the team is behind by 1 goal with 1 minute left, then the opposition scoring on an open goal doesn’t change anything – but having an extra man forward has a chance to change the outcome.
Key point: volatility helps the out-of-the-money option. Higher volatility raises the delta (loosely thought of as the chance of ending up in-the-money) of an out-of-the-money option. Similarly, higher volatility lowers the delta of the in-the-money option. This is why there are October surprises.
Time works on options pricing similarly to volatility (fun fact – doubling the implied volatility has the same effect as quadrupling the time to maturity, I the Black-Scholes world). As the expiry of the option approaches, the delta of an in-the-money option gradually rises until it gets to 1.0 at expiry; the delta of an out-of-the-money option gradually declines to 0.0. It’s the same reasoning. With more time to play, there are more chances for good (outcome-changing) accidents to happen to the person who is trailing, and more chances for bad accidents to happen to the person who is leading.
In the context of the election, here’s what this means. (Note: remember this is just an illustration, not a prediction. It’s a pricing model where I’ve made lots of assumptions so as to be able to show this point).
If Trump still has a similar lead in the national polls in two months, his odds of winning will rise – to something like 70%, versus 60% now. After that, it will rapidly go to 100% over the ensuing weeks. And so event contracts will behave likewise…Trump contracts should gradually rise, even if nothing changes, as the opportunities for changes in the race get narrower.
Two more caveats.
One: the option here is not really a European exercise that is determined on November 5th. Since there is such a thing as early voting, the effective expiry is closer. If Trump is leading on October 15th, he’s accumulating actual votes. So it’s really like some kind of weighted average-price exotic option. But the point is, the delta decay will happen faster than I’ve modeled, for that reason.
Two: I’ve assumed volatility is constant. It most assuredly is not constant. Implied volatility ought to rise as we get closer to expiry (October surprise!). That will tend to offset the delta decay that I have modeled.
In summary – don’t take this as trading advice, but as a hopefully useful insight into how deltas (and binary contracts) evolve over time. I hope you found this interesting.
[1] Obviously, we know that’s not right because the US elects Presidents based on the Electoral College process, which is the result of a compromise between those who wanted the President selected by Congress and those who wanted the President selected by popular vote. In recent years, the winner of the popular vote hasn’t always won the Presidency because the most-populous state, California, has overwhelmingly voted Democrat and skewed the popular vote numbers.
The Residual Effect on Rent Inflation of the Eviction Moratorium
Today’s column will be a brief one, because it’s summertime and the people on the beach generally don’t read my column. I saw a headline today for an article on Realtor.com. “June 2024 Rental Report: Median Asking Rents Continue to Fall.” Here is the first chart, under the title ‘Rents Decline Again,’ which unironically shows asking rents are rising (but, on a y/y basis, still a tiny bit lower than a year ago.
My article though is not meant to beat up on the journalistic merits of this article. No, I want to run back a chart I showed a couple of years ago which was interesting at the time and – what surprised me when I updated it yesterday – is actually still interesting now.
The chart shows asking rents (Source: US Census), effective rents (Source: REIS), and the CPI for Rent of Primary Residence (Source: BLS). When I first ran this chart, the point was that the eviction moratorium instituted by the Biden Administration had held down realized rents, but opened up a large gap between actual rents and asking rents, which meant that there would eventually be a large catch-up. Prior to the eviction moratorium, these three measures paralleled quite well – as one would expect them to. But the point of divergence is obvious, as was its implications (and I noted them for example back in March 2021. You’re not wasting your time here, people).
Sure enough, rent inflation accelerated sharply when the moratorium ended.[1] Look at how the red line moved smartly up towards the blue line starting in the summer of 2021. The BLS measure, with a lag, also accelerated, and now has just about caught up to the Effective Rents measure. The animated discussions you hear today about how rents are still rising in the CPI even though effective rents and rents for new apartments are in some cases declining is mostly an argument about lags. The BLS series understated rent inflation for a while, and has been gradually catching up. It’s almost there.
But the interesting part to me is the blue line, especially in the context of an article about how “Asking Rents Continue to Fall.” I would absolutely expect asking rents to be falling, since they are up about 41% since the divergence began while effective rents are up only 18% or so. The curious part is the question about why this divergence has recently re-accelerated, and the secondary question about whether asking rents lead effective rents as they did during the eviction moratorium. That, though, was an unusual event and otherwise there doesn’t appear to be a lead relationship there.
There also, though, hasn’t previously been such a divergence. I wonder if the elevated asking rents measure is due to shortages of rental properties in areas of the country where the population growth (of both legal and illegal migrants) is hot. I don’t know. What does seem to be clear here is that the eviction moratorium caused massive turmoil in the rental market, and that volatility is continuing even today.
All the more reason to hate the idea of price controls on rents! Stop poking the hornets’ nest and let the market settle down.
[1] The Congressional eviction moratorium enacted as part of the CARES Act ended on July 25, 2020. The CDC unilaterally ordered the ban extended and imposed criminal penalties on violators. Congress extended the moratorium for one month, and the CDC again declared it to be continuing. A series of court decisions in July 2021 made clear that the CDC’s action was unauthorized by Congress and therefore unconstitutional. On August 3, 2021, the CDC extended the moratorium anyway but landlords felt more comfortable ignoring it. Various states extended the moratorium for a while within their states, but the nationwide moratorium effectively ended in July 2021. Wow, this footnote was longer than I thought my whole article would be.
Inflation Guy’s CPI Summary (June 2024)
Let’s set the stage. Last month (May’s data), core CPI printed at +0.16% and +0.25% on Median. But a lot of that, most of it, was core goods and the question was whether that month was a one-off due to be reversed at some point, or if shelter and other slower-moving things would come along. Coming into this month, the economists’ consensus was for +0.21% on core; the inflation swap market trades headline inflation but actually implied something a tiny bit softer than the economists were expecting. We knew Used Cars was going to be weak again, but it seemed like people were all-in on the idea that the worm has turned and now inflation is going to head sharply lower.
Whether this turns out to be true or not, it’s important to realize that the reason economists think that is because unemployment is rising, indicating that we are either in or very near a recession, and economists think (against logic and data) that wages lead prices so this should herald a disinflationary pulse. Now, I also think inflation is headed lower, but it’s because shelter is coming off the boil and not because the Fed successfully cracked the backs of labor.
So what happened this month?
We saw a very weak headline number of -0.06%, which was mainly the fault of a very weak core inflation number of +0.06%. That’s the second quite weak core figure in a row, and when median CPI comes out later today it should be even weaker than last month, at +0.195% or so. If we could repeat that median every month, it would be tantamount to inflation being at the Fed’s target because median normally tracks a little higher than core except when we are in an inflationary upswing.
But whereas last month’s inflation figure was all about core goods, this month we finally saw a bit of a deceleration in shelter. Okay, yes – core goods slipped further into deflation, because that category exists mainly to make me look stupid by going lower and lower when I keep thinking the disinflation must be nearly wrung out. Core Services dropped to 5.1% y/y from 5.3% y/y.
We had known Used Cars would be weak, and it was at -1.5% m/m. New cars also dragged. But I will say it again because I want to have the chance to appear stupid again next month: goods deflation is running its course. Global shipping costs are rising again, the dollar will be vulnerable if the Fed begins to ease, and while used cars should continue to show large y/y declines for the next few months that’s mostly base effects. On an index level, the used cars price index is almost all the way back to the overall price level. Since COVID, the general price level – what has happened to the average price of goods and services – is up 22.3%. Used Car prices are now only up 27.7%. Not all goods and services will move up exactly 22.3%; the point is that the dislocation in used cars is pretty much over and therefore we should expect at some point that used car inflation will start to look more like overall inflation.
But again, goods aren’t the story we really care about. The question is, what about services? The news here is all non-bad. (Some of it is good, some is just not bad.) This month, the story is that rents abruptly weakened on a m/m basis. Primary Rents were +0.26% m/m (was +0.39% last month), and Owners’ Equivalent Rent was +0.28% (was +0.43% last month). This dropped the y/y rates to 5.07% and 5.45%, respectively.
That’s good news, but it is not unexpected news. The conundrum over the last 3-6 months has been why this wasn’t already happening. On a m/m basis, the rent numbers probably won’t get a lot better, but if they print around this level consistently then the y/y rent numbers will decelerate gradually. Unfortunately, there is no sign of deflation in rents and they are likely to begin to reaccelerate later this year, or early next year. That is an out-of-consensus view, though, and you should keep in mind that the Fed believes we have imminent deflation in rents.
In addition to the softer rents numbers, Lodging Away from Home showed -2% m/m. However, like airfares (-5% m/m), LAFH is not something that is going to be a persistent large drag. It’s volatile. On airfares, this decline in prices matches nicely with the energy figures we saw yesterday that showed a surprising fall in jet fuel inventories. Prices dropped and people flew!
Moving on to “Supercore.” People made a lot last month of the m/m decline in core services ex-shelter, and they’ll make a lot of the fact that it declined m/m again this month. But that looks like a seasonal issue: last year the two softest months were also May and June. On a y/y basis, supercore showed another slight decline. Medical Care Services is 3.3% y/y, with Physicians’ and Hospital Services both holding pretty steady at a high level. I don’t see any major improvement in supercore yet.
Overall, there’s no doubting that this number is soothing for the Fed. It’s soothing for me too. Inflation is decelerating, and as I said last month I think the Fed will almost certainly deliver a token ease in the next couple of months.
The potential issue is that inflation isn’t slowing for the reason the Fed thinks it is. The economy is slowing, and unemployment is rising. I don’t know when Sahm first said it, but for decades I’ve been noting that when the Unemployment Rate rises at least 0.5% from its low, it always rises at least 1% more (here’s a time when I said it in 2011: https://inflationguy.blog/2011/07/10/no-mister-bond-i-expect-you-to-die/ ). Not that I’m bitter that it’s called the “Sahm Rule” now.
So yes, the economy is weakening and the labor market is softening. And that presages a deceleration in wage growth – or, really, a continuation in that deceleration. But the connection between wages and prices is loose at best, and that’s not why inflation will stay low, if it does. In fact, I continue to believe that median inflation will end up settling in the high 3s, low 4s. There has always been an ‘unless’ clause to that belief, but it isn’t ‘unless we enter recession.’ We will enter into one, and probably already are, but recessions and decelerations in core inflation are also only a loose relationship at best. It isn’t the recession which is causing disinflation (after all, the disinflation started long before now). What may is the slow growth in the money supply, combined with the rebound in velocity eventually running its course. We are closer to the end of the velocity rebound than to the beginning, and while M2 is accelerating it isn’t problematic yet. Those are the nascent trends to watch closely.
In the meantime – the Fed has what it wants for now. Soft employment and softening inflation. An ease will follow shortly. Whether that is followed by further eases remains to be seen, but…for now…the trends are favorable for the central bank.
