Trading the FOMC

Trade Ideas from Monetive Wealth on the eve of FOMC

We posted the first article in the series before the February FOMC meeting and we intend to make this a regular post prior to every FOMC meeting.

Tomorrow’s FOMC is likely to be different in many way from any other in recent times. We have a prefect storm of runaway inflation, hot economy, supply disruption from pandemic and raw material disruption from the war. The stakes are high for the Fed to thread the needle and soft-land the economy. While the job is difficult in the best of times it appears to be an impossible task in the current situation

Inflation has gone so far out of control that waiting for it to settle is no more feasible and the fed has no one to blame but itself in letting it get away out of control. They have overstimulated the economy and kept at it even when the data told them to stop. For this meeting the choice in our opinion comes down to a neutral or hawkish stance. I suppose we could talk about levels of hawkishness that are possible but that is not really going to change anything. In both the scenarios the rate hike is going to be 25 basis points. It is the commentary that will decide the direction.

Let us look at the 2 scenarios and how to trade it:

Best case for the market is Fed is neutral and raises by 25 basis points but calls for inflation to peak soon. This almost certainly means that the Fed also sees greater risk to the economy from aggressive policy action on rates or balance sheet. This scenario would likely set up a bounce in the market from the current oversold levels and might keep running until the Q1 results. We see this first as an opportunity to trade the run and also to get out of positions on any rip especially ones that did not beat and guide up last quarter.

2 trade ideas for neutral FED:

We think the best trade will be in tech sector since that has come off the most from recent high.

So many tech growth names have damaged charts. These charts need time to repair and then setup. But for a quick short covering rally the easy trade would be long TQQQ. I would not hold the calls overnight. The reason for this is mainly that the FOMC event risk premium will come out of options. Plus, a move up is usually accompanied with falling VIX. All this boils down to loss of option premium.

If market stabilizes, then due to quarterly rebalance + inflows into the market, GOOGL can test its highs. GOOGL’s 20:1 split is also one consideration.

This is GOOGL’s chart:

A call butterfly 2650/2675/2700 for March 18th expiration for $1.5 debit per contract is the trade we plan to enter. So the trade is to buy GOOGL butterfly for $150 per contract to possibly make $2350. the max loss on this trade is the debit paid.

Here is a video explaining the trade:

Another trade that we already got filled is for April 14th monthly expiration for 3000 pin. For that expiration, according to the expected move, too it should get to 2828 which is the weekly POC. But based on open interest, and in general round number 3000 is possible. So, this is another lotto trade. We already got filled for a 2950/3000/3050 Call butterfly for .9 debit. In this case, if GOOGL gets to 3000 and pins by April 14th expiration then the $90 can potentially make $4910.

The second scenario is more of an acceptance that they are indeed late to the party and need to be more aggressive control runaway inflation quickly and deal with the consequence of policy action at a future meeting. Here we still expect a 25bps hike but an acknowledgement that prices are not likely to come down by itself. They could also talk about their plans to deal with the balance sheet especially the MBS. While they are very unlikely to set a date for QT, the market will make its assumptions from the fed statement, the press conference and the dot plot.

Hawkishness will be a negative for the overall market but will provide some positive tailwind for the financials especially Regional Banks/Insurance (Interest rate sensitivity) and Capital Markets (oversold bounce with some positive from interest rate).

We looked around for a safe and profitable trade for a hawkish commentary. We saw some significant options flow for KRE (Regional Bank ETF) for September, 2000 contracts for 80/85 call spread. September date could be interesting. 6 months would give enough time to see the impact of the first 2 Fed rate hikes in March and May meeting. KRE has stronger seasonal performance in Q3 compared to Q2. It is also just before the elections so further policy action might be on pause.

Our trade is a KRE September 16th expiry 75/77 Call Spread financed by selling a $55 put for a credit of $2.

As always these are trade ideas. Please do your own due diligence before you take any trade. Talk to your financial advisor or RIA to find the investment appropriate to your own financial situation.