US Government Shutdown: How investors might play it

* A looming shutdown presents option-selling opportunities

* Prolonged delay in economic data would stir uncertainty

* Potential bond market trigger, but past shows otherwise

* For long-term investors there’s little cause for concern

By Herbert Lash and Doris Frankel

NEW YORK/CHICAGO, April 7 (Reuters) – There may be some
quick profits to be made if the United States goverment shuts
down.

Rather than running for the hills in panic, investors may
want to take some money off the table now and simultaneously
set up some options positions to profit from a recovery once
the crisis is over.

If Democratic and Republican congressional leaders fail to
reach a budget deal for the rest of the current fiscal year by
midnight Friday, the government will have to stop operating,
apart from vital services such as defense and law enforcement.

A response on Monday might be selling pressure in U.S.
stocks and the U.S. dollar on concern that the shutdown could
be prolonged and hurt the U.S. economy, which is still in the
early stages of a recovery from the financial crisis.

But the longer the shutdown the more likely lawmakers could
face a political backlash from voters — which means that they
should feel pressure to quickly return to the table and reach a
deal.

A prolonged delay in U.S. economic data, which will not be
published in the event of a shutdown, could create anxiety as
well. If investors don’t have a clear understanding on the
state of the economy, they could sell U.S. assets. For details
see: [ID:nN07146516]

“I would be inclined to be a net seller of volatility in
interest rate products,” said Jared Woodard, principal of
research and trading firm Condor Options in New York.

A sell-off in Treasury bond futures in recent days has
helped increase implied volatility, while the expected
magnitude of any Treasury bond futures movement creates some
option-selling opportunities, he said.

If implied volatility rises further, Woodard might sell
short-term options on U.S. Treasury bond futures, and hedge
that position by buying options at the same strike price but
with an expiration date further out, he said.

An investor might buy a straddle in SPDR S&P 500
exchange-traded funds, a strategy that is often used to measure
an expected move of a security or index in either direction
ahead of a risk event, Steve Place, a founder of options
analytics firm investingwithoptions.com in Mobile, Alabama.

A stradle combines a call and a put with the same strike
price and expiration date, giving the buyer the right to both
sell or buy the underlying asset at a set price.

Congress on Thursday neared a budget deal to avert a
potential shutdown but disputes over abortion and environmental
issues posed hurdles to an agreement before the deadline on
Friday at midnight. [ID:nN07296632]

Shutdowns in 1995 and 1996 suggested a slight drop in
quarterly growth of 0.09 to 0.17 percentage points, while a
stop now could hinder the initial reliability of upcoming data,
Nomura Securities said.

A shutdown is an “event” for the market as it gets many
people stirred up and upset, said Axel Merk, president and
chief investment officer of Merk Mutual Funds, in Palo Alto,
California.

Bond markets are likely to stay calm, he said.

Some U.S. investors are adopting “quick trades” as many
believe any shutdown would be short-lived.

Investors are positioning for a so-called “bear” steepening
of the yield curve, when long-term rates rise faster than
short-term rates, said Bret Barker, a portfolio manager at TCW
in Los Angeles, who warned the trade might not last long.

“As soon as they pass the budget, we all should be going
back to where we were,” he said. “The 2 year is a little safer
since it is a short maturity and has less risk, but longer
dates, say 10 year and out, might be under selling pressure.”

When the government shut down in 1995 for 21 days the bond
market rallied in anticipation of greater fiscal discipline.

U.S. financial markets have barely flinched since a
showdown over government funding began to catch headlines.

“This is a perception game and may generate a sell-off in
U.S. equities. If there is a shutdown and it spooks markets,
then I want to take a position in which ever asset class gets
hits the most,” Woodard said.

“So if the pop in implied volatility is greater in U.S.
equities reflected by the CBOE Volatility Index, than it is in
the interest rate complex, I would rather be an outright seller
of short-term VIX futures.”

Those with a longer view of the market and fundamentals,
the shutdown is more of a nuisance, not an opportunity.

Shutdowns in the past have been of limited duration, making
their impact on both the economy and markets modest and
transitory, said David Joy, chief market strategist at Columbia
Management, which oversees about $347 billion in assets.

“We have made no changes to our asset allocation
specifically in response to the possibility of a shutdown, but
are mindful of the potential drag on economic activity should
it extend beyond our expectation.”
(Additional reporting by Jennifer Ablan in New York)
(Reporting by Herbert Lash)

US Government Shutdown: How investors might play it