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Sang Lucci

Sang Lucci has been successfully trading options for over six years. He began his career at a proprietary trading firm where he studied the techniques of other traders while managing his own account...

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Fed Up With The Fed? Protect Yourself, Just In Case

The Federal Reserve is getting a bit tiring these days.

During the meeting (usually Tuesdays and Wednesdays), the US equity and option markets slow down and trading ceases to exist. Traders of all types, for whatever reason, are worried that the Fed is actually going to do change its policies and affect the US markets.

When was the last time the Fed did any action? According to useconomy.about.com, it was December 17, 2008, when the overnight federal funds rate was lowered to zero. Although technically it was “between 0.25% and 0%”… who cares? The country has been in a moderate depression for five years and apparently those in the finance industry are trying to pick the bottom of the interest rates via the language that Bernanke and the Federal Reserve Board use in their 2:00 pm statement and/or the minutes that come later. It makes little sense.

By the way, the reaction in the market when those minutes come out is also maddening. As if things have changed from Bernanke's statement 20 days prior. Nothing has changed. It is an event that could stab a trader in the eye when S&P (NYSE: SPY) rips $2 for no reason.

And another thing: why are the meetings scattered so randomly? Just hold them quarterly and be done with it. And after seven years, why is it that virtually no one can pronounce Bernanke's name except for Maria Bartiromo?

Now obviously the Fed Funds rate announcement is not as simple as it was made out to be above. If and when the rate does change, there will be a massive chain reaction between the US bond market equity markets, which will, in turn, increase volatility in the US equity options market. Economics 101: when stocks go down, rates go up.

But, sometimes traders' methodology is based on the notion that the Fed Funds Rate increasing is a good sign for the US economy, so stocks will go up too. But other times an increase in rates is viewed negatively, so traders wait three weeks later and crush the US equity market when the Fed minutes are released.

The important thing to know: fade any move. Rarely is there any significance after an unchanging Fed Funds rate announcement, as the Fed Funds rate has not changed in half a decade. It is the Event That Cried Wolf. When the post-Bernanke Fed Chairman one day announces that the Fed Funds rate is officially 0.25 percent, all hell will break loose. Or maybe it won't, because it was already priced into the market.

When the CME and the Fed announced an impromptu rate drop in the middle of the trading day back in 2000, traders poured into the S&P 500 futures pit like a herd of cattle. Guys were coming out of the woodwork-- it had that World War Z kind of feel. Now that was a Fed event!

So essentially, the Federal Reserve meeting is not like what it used to be, so head this advice: fade the move. But maybe look to buy some protective options, just in case.

Posted in: Short Ideas Options Economics Federal Reserve Markets Trading Ideas