Whenever the Fed Chair speaks, the market listens. After a brief rally over a couple of days, the market paused to listen to Fed Chair Powell testify before Congress. What he said was that the economy is stronger than expected considering the previous interest rate hikes. He reiterated that the Fed will not only stay the course and keep raising rates but they will increase the sizes of their interest rate hikes as they deem necessary. The market ended the session down 1.5% for the Dow, 1.36% for the S&P 500, and 1.16% for the Nasdaq. While the market fell on news of more and stronger interest rate hikes, options trading on interest rate and Fed news can be profitable.
Is It Fed Speak or a Clear Message?
Going back to Alan Greenspan as chair of the Fed, the chairperson often parses his or her words in order to avoid spooking the market. However, this time around the Fed has orchestrated a campaign to make the point that rates are going up, the economy is going to be slowed, and there will be economic pain before they are done. While the usual task over the years has been to parse the words of the chair to divine the real meaning of their words, that is not the issue now. Rather, the issue with the market is one of wishful thinking based on too many years of easy money and low interest rates. Powell speaks and then several regional Federal Reserve Bank presidents repeat the same message over a week or so. What is potentially tradable is a market that may discount everything that the chair has said until it becomes painfully obvious that he and his crew mean what they say and will keep raising rates until they get inflation down to their 2% goal.
How Certain Is a Recession?
More often than not, when the Fed raises rates to quell inflation, they end up slowing the economy sufficiently to cause a recession. One issue is that a recession is not “official” until there have been three quarters of negative GDP plus other measures. Thus, we are probably in a recession right now and by the time it is made official the market will actually be ready to go up again. Thus, a smart options trader will be able to avoid letting current market sentiment (often misguided) fool them and place hedged trades that profit from how the market would like to see the situation and how the market will really react.
Options Profits During Good Times and Bad
One of the great parts about trading options is that a trader can change strategies in a moment in order to profit when the market changes direction. Those who have followed our efforts have seen how we called the Covid Crash to the day and called the recovery within days. Both times we pivoted and virtually printed money while the “smart money” was still stuck in “yesterday’s” market strategy. Long term stock investors can get wiped out during a market crash while we at Top Gun Options make profits with bearish trades or go long on volatility.
One of the keys to successfully trading options in difficult markets is to pay attention to what is going on in the broader world and not just on the screen that shows the S&P 500. That is why we so often talk about what the DRINC folks are up to, our acronym for Democrats, Russia, Iran, North Korea, and China. When Covid broke out we paid attention to experts who predicted a global pandemic and massive economic disruption instead of folks who wishfully said Covid was just another flu. The coming recession will likely be worse than anticipated and the market may well suffer more than expected. Meanwhile, the trading squadrons at Top Gun Options will adjust strategies to fit the market we have and not the one we wish for and potentially print money.