Spreads are an options strategy to deploy during uncertainty
The Federal Open Market Committee (FOMC) meeting kicks off today. With bank stocks under the microscope, the Fed's two-day policy event-- and subsequent comments from Fed Chair Jerome Powell -- has thrown a wrench into what investors are expecting tomorrow.
The CME FedWatch tool indicates an 82% probability of a 25 basis-point hike, a little more dovish than what many were probably expecting two months ago. Schaeffer's Senior V.P. of Research Todd Salamone has much more on fed funds futures here.
We posed the question; are there specific options strategies out there catered to moments like these?
Spitty, Spitfire Traders
In the event of potentially softer rate hikes by the Fed, keep in mind these options strategies:
Straddle: When market uncertainty is high, the straddle can be effective. This involves buying both a call and a put option at the same strike price and expiration date. In this scenario, should the market experience a significant move in either direction following the Fed announcement, you stand to make a profit..
Vertical Spread: A vertical spread involves purchasing and selling call or put options with the same expiration date, but different strike prices. For example, if you believe that the market will rise moderately, you could buy a call option with a lower strike price and sell another call option with a higher strike price. This limits your risk while still allowing for profit if the market reacts positively to the Fed announcement.
Iron Condor: In situations where you expect the market to remain range-bound or exhibit limited volatility, an iron condor strategy can be advantageous. This involves selling an out-of-the-money call and put option, while simultaneously buying a further out-of-the-money call and put option. This creates a net credit, and you stand to profit as long as the market remains within a certain range.
Calendar Spread: A calendar spread is another strategy suitable for times of uncertainty. It involves selling a near-term option and buying a longer-term option, both with the same strike price. If the market remains relatively stable after the Fed announcement, the near-term option will decay in value more quickly than the longer-term option, allowing you to profit.
June Jia, Master of Financial Mathematics from the University of Minnesota
Owner of Canny Trading & Quantitative Researcher at GF Securities
If the Federal Reserve announces a more moderate rate hike next week, it would be advisable to consider options trading strategies such as the short strangle or iron condor. A moderate rate hike implies that the Fed's tightening cycle is nearing completion, which in turn suggests that the factors contributing to significant market volatility throughout 2022 and early 2023 will gradually diminish. Consequently, market volatility is expected to decrease over time.
Both the short strangle and iron condor strategies are designed to capitalize on the income generated by declining market volatility. As such, these options trading strategies are particularly well-suited for the anticipated market conditions following a more moderate rate hike announcement.