Sure, Fade the Fed -- But Be Careful

Today's Fed decision may not represent the type of seminal moment Wall Street and the media are expecting

Sep 17, 2015 at 8:25 AM
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    What’s the best way to profit from today’s incredibly big announcement? Do the opposite, says George Costanza ... I mean, Mark Hulbert:

    "Making money from the Fed's interest-rate meeting this week should be easy: Just do the opposite of what most investors do immediately after the decision is announced.

    "I say this because the timing of when the Federal Reserve decides to raise rates makes no significant difference in the real world. So we can be assured that the market's immediate reaction to that decision, whatever it may be, will soon be corrected."

    Fading the Fed, indeed, is often a good idea, even on less important meetings. We often see a reaction immediately after the announcement, and then a reversal of that reaction the next day, such that a close or two later, the net move is minimal to non-existent.

    But what of this go around? We're so focused on it that it must make a cosmic difference, right? Well, maybe not:

    "I readily concede that you would never guess that the Fed's rate-hike decision is so meaningless, given Wall Street's and the media's hysterical obsession with it. But when I asked a number of economists why the timing of the rate increase really matters, none could come up with a plausible story.

    "On the contrary, they told me, the stock market's fair value will be nearly the same regardless of whether the rate increase comes this week, or in December, or sometime next year or even thereafter."

    I very much agree. It's kind of a running joke how this has become some insane inflection point in foresight. I'll guess in hindsight we're not going to view this as any sort of seminal moment.

    But while I do believe fading the Fed is the right call, I would also note it's right to be careful. We don't know exactly how much of a move the markets will anticipate at 2 p.m. ET today. I mentioned the other day that it looked like about a 1.5% move, but that's a fluid number. It's also just a snapshot. Not everyone bought or sold at the same volatility, and thus, some players have bigger cushions than others. But for argument's sake, let's assume that's more or less an equilibrium.

    Why does that matter? Well, if we do see an outsized move from the get-go, it's going to trap volatility shorts. If they get squeezed, then they pretty much have to pile onto the move, further exacerbating it. If the market's expecting a 1.5% move or so, and we see a 2% move, it suggests those trapped shorts will have to defend losing positions. Fading the Fed becomes a bit trickier in that sort of situation. I do think the early move will retrace, it would just take longer to play out.

    Conversely, if we see a smaller move, the volatility longs will be under pressure. It's not as intense as when vol shorts get squeezed, as the losses aren't open-ended. But it's real and it puts pressure back to the flatline, similar to the pressure of a "pin" on normal expiration days.

    Regardless, if you're of the opinion that this move is overstated from a fundamental standpoint, it pays to fade. I love the idea of selling put and/or call spreads (condors, if you do both). It's a nice, defined-risk way to sell some premium.

    Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research.

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