INVESTOR INSIGHTS

2026

Hedging the Known Unknown: The Midterm Elections

We know the date. We do not know the result.

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INVESTOR INSIGHTS

2026

Yesterday a client called me, a little rattled. Like many successful people, he works with more than one advisor, and his advisor at one of the big banks had just told him to get out of equities and rotate into fixed income before the midterms. The reasoning went like this: the president has been juicing the stock market, a Democratic win in the House would take that power away, and the market would crash.

He wanted to know whether we should do the same. My answer was no. Not because I know how the market will greet the result. Nobody does, and anyone who says otherwise is selling something. We simply have a different approach.

If you are worried a storm might damage your house, you buy insurance. You do not sell the house, pay the realtor, write a cheque to the government and rent across the street until the weather clears. Yet that is roughly what a rotation into bonds ahead of an election does to a portfolio.

Look closely at the theory first. It needs three things to be true at once: that one person in Washington has been holding up the world’s largest stock market, that losing the House takes that power away, and that the market has not already priced in a result it has spent weeks betting on. Any one of those is a stretch. All three together is not prudence. It is a forecast dressed up as prudence. History does not support it either: the S&P 500 has risen in the 12 months after every midterm election since 1946, including the six where the president’s party lost the House.

Then look at how the advice is built. If the market falls, the advisor was prudent. If the market rallies, he simply erred on the conservative side, and nobody in our industry gets fired for that. It is a get out of jail free card. The advisor’s reputation is protected either way. The client’s portfolio is not: in a taxable account with large gains, he can hand the government more than a tenth of the portfolio years earlier than necessary, then sit out whatever rally follows.

There is a better way to be careful. You do not have to err on the so called conservative side. You can buy the protection directly, and insure the portfolio against a sharp fall for exactly as long as the risk lasts.

The traditional portfolio manager has two levers: own equities, or sell them and rotate the proceeds into fixed income such as bonds. A portfolio manager licensed to use options has far more tools. In a moment like this, buying a put can be the more efficient choice, both for your tax bill and for your upside.

Where the traditional manager is selling, we are buying.

INVESTOR INSIGHTS

2026

The Direct Answer

A put option is the right to sell an investment at a fixed price until a set date. Buying one on a broad market index works like an insurance policy on a portfolio that tends to move with that index. If the market falls, the put rises in value and helps offset the paper losses in the portfolio. If the market rises, you keep the gain, less what the insurance cost.

The real difference shows up if the advisor’s prediction of a collapse turns out to be wrong.

If we buy the put and the market rallies instead, the insurance expires worthless. The client has lost the premium and kept the rally. In a taxable account, that premium is generally a capital loss that can be used against capital gains.

If the traditional manager sells and the market rallies, the client misses the rally. Selling also brings a tax bill forward and, worst of all, leaves a second decision: when to get back in. In a market that stays flat or goes up, the client in a taxable account has paid the tax early and missed the gains as well.

One approach costs a premium. The other costs a tax bill and the upside.

Understanding Your Financial Tools: The Put Insurance Policy

In our view, the put is the right tool for this job. Still, there are four things to know before buying one.

1. Most of the time, you pay for nothing. That is how insurance works, and the premium is gone if the market does not fall. It makes sense for a specific event. As a permanent habit, hedging can get expensive, so you want to be selective and opportunistic. At Frontwater, we are more inclined to layer on hedges around a known event with an unknown outcome, or when markets are trading near record highs.

2. An index put hedges the index, not your portfolio. If you own 25 Canadian dividend payers, an S&P 500 put protects you only to the extent your holdings fall with the U.S. market. A Canadian portfolio may be better matched with options on a Canadian index fund, such as XIU, listed on the Montreal Exchange. Hedges in U.S. dollars also carry a currency effect of their own.

INVESTOR INSIGHTS

2026

3. Insurance expires, so match it to the risk. A put protects you until a date. The appeal of an election is that the risk window is short. Once the results are known, the uncertainty is resolved and the market reacts, one way or the other. That is why a put expiring on Friday, November 6 covers the event itself. A slightly longer expiry, such as November 20, adds room in case the result is contested or the market takes time to digest it. The shorter the policy, the less it costs in total, though the more it costs per day.

4. It takes permission and attention. Your account needs options approval.

The Frontwater Lens

Here at Frontwater, we pride ourselves on building portfolios that are risk managed, transparent and designed for the long term. In our view, the most dependable hedge most investors will ever own is still the plainest one: a well diversified, balanced portfolio of high quality companies, held with a time horizon longer than a news cycle.

Still, for the days or weeks when a known event might keep a client up at night, a put is often a better tool than a sale. The cost is fixed and known in advance, the portfolio of high quality companies stays in place, and if the feared drop never comes, the worst case is a premium you did not end up needing.

The Bottom Line

Elections come and go, and by the time many of you read this, this one will have been called. There will be another scare after it. There always is. When it arrives, ask what you are actually trying to protect and what that protection is worth paying for. More often than not, the answer is a policy, not a moving truck.

Insure the house if you need to. Just don’t sell it.

INVESTOR INSIGHTS

2026

Frequently Asked Questions

How does a protective put compare with selling stocks before an election? A put limits the downside on the hedged exposure for a known cost and keeps both the upside and, in a taxable account, the tax deferral. Selling removes market risk entirely but gives up the upside and can bring tax forward. Which fits depends on your time horizon, your accounts and how long you want cover. The premium is a real cost and is lost in full if markets do not fall.

Does buying a put trigger capital gains tax in Canada? Generally not, because buying a put is not a sale of the shares. Arrangements that remove substantially all of both the risk and the upside for more than a year can be deemed a sale under section 80.6 of the Income Tax Act. Confirm your own situation with a tax advisor.

How much does it cost to hedge a portfolio with puts? It depends on the strike, the length of cover and how nervous the market is. On the morning of November 3, 2026, a put on SPY at about the market price and expiring November 6 cost about 0.8% of the value it protected. That price will differ on any other day.

How has the stock market performed after midterm elections? The S&P 500 rose in the 12 months after all 20 midterms from 1946 to 2022, by about 14.8% on average, measured on price alone, in U.S. dollars. Past performance is not indicative of future results.