The High-Stakes World of Shorting and Election-Driven Trades

Investors are navigating the high-stakes 2024 election with asymmetric trades, balancing potential gains in assets like Bitcoin and the yuan with strategies to mitigate downside risks in an uncertain political landscape.

Shorting stocks, a high-risk strategy that profits from falling share prices, remains both challenging and controversial. Unlike traditional “long” investments that benefit from rising markets, short sellers face asymmetrical risk: a stock halving in value yields a 50% gain, while a doubling causes a 100% loss. With global markets hitting record highs recently, this approach has proven difficult for some funds, prompting several managers to reassess their strategies.

For others, however, a disciplined, quantitative approach has led to strong results. Certain funds have employed proprietary “red flags” models, screening thousands of stocks daily for indicators of potential underperformance. One fund, which focuses on individual stock analysis rather than macroeconomic predictions, attributes much of its recent success to this granular approach. The fund’s model considers unusual market signals, including options data, insider transactions, and employee reviews, to identify weak stocks before broader market shifts impact them.

Despite the complexities, the appeal of shorting remains, especially as managers seek hedges against traditional equity exposure. Unlike high-profile investors who famously bet against the U.S. housing market ahead of the 2008 financial crisis, this fund avoids top-down calls, focusing instead on stock-specific signals that bypass broader market predictions.

Asymmetric Trades in the 2024 Election

The impending U.S. presidential election has driven a wave of asymmetric trades—bets that offer substantial upside with limited downside. Hedge funds and investment managers are navigating an almost deadlocked race with innovative strategies that can profit regardless of who wins. Many are eyeing assets like Bitcoin and the Chinese yuan, anticipating a favorable regulatory environment under a Republican administration. Should the results swing the other way, however, the downside on these trades is expected to be more limited.

For instance, Bitcoin is favored by some funds due to its potential regulatory boost if Republican policies are enacted. Certain macro funds are also exploring currency-based trades, particularly shorting the yuan against the dollar, as renewed tariffs could pressure China’s currency. These trades are considered asymmetric: a victory by Republican candidates could lead to significant gains, while the downside in a Democratic win would be relatively contained.

As polls continue to fluctuate, funds are keeping a close watch on prediction markets and betting platforms to gauge sentiment. Some strategists, concerned about overreaction, have begun taking profits on early gains. The uncertainty surrounding the election, combined with rising inflation and deficit expectations, has led certain funds to reduce exposure to bonds, anticipating higher yields if a Republican victory pushes through stimulus spending.

A Careful Balancing Act

As market sentiment shifts quickly, investors are cautious about holding onto volatile positions. Analysts are managing portfolios with a mix of long and short positions, neutralising directional exposure to limit downside risk. This approach allows potential gains from one trade to balance losses in another, reflecting a prudent stance in the face of high-stakes uncertainties.

Some funds have pivoted towards less aggressive election-driven trades, recognising that a Democratic victory could represent a return to status quo policies, limiting potential losses. With hedge funds posting strong, though not spectacular, gains in recent months, there is added pressure to maintain cautious optimism. Some managers are preemptively reducing their election-driven positions, anticipating a volatile reaction in the days leading up to and following the election.

Taking a Strategic Step Back

As election day approaches, the market’s reaction to poll movements has led some funds to reconsider their positions. Analysts at major firms note that the recent selloff in Treasuries and adjustments in currency markets may be overdone, with potential for correction post-election. Many are advocating a step back, advising clients to lock in gains and maintain liquidity until the election’s outcome becomes clearer.

With the stakes high and the results uncertain, the allure of asymmetric trades persists. Investment firms are navigating these opportunities carefully, balancing the potential for substantial upside with the need to mitigate losses in an unpredictable environment. As market volatility remains elevated, funds are strategically positioning themselves to profit from shifts while limiting exposure to downside risks, staying ready to pivot as the political landscape evolves.