How Large Option Traders Are Reacting To The Interest Rate Cut

The markets traded lower on Wednesday after the Federal Reserve lowered interest rates by 0.25%, in-line with economist expectations.

Following the Fed announcement, investors must determine how to play the news. There were at least two large trades in the option market on Wednesday that provide some insight into what traders are thinking.

The Trades

On Wednesday afternoon, Benzinga Pro subscribers received option alerts related to Citigroup Inc C and The Coca-Cola Co KO following the Fed announcement

At 2:17 p.m, a trader bought 906 Citi put options at a $70.50 strike price that expire on Aug. 9. The puts were purchased at the ask price of 71.2 cents and represent a $64,507 bearish bet against Citi.

At 2:25 p.m., another trader sold 2,500 Coca-Cola $53 calls expiring Friday at the bid price of 22.1 cents. The sale represented a bearish bet worth $55,250.

Why It’s Important

Due to the relatively complex nature of the options market, options traders are generally considered to be more sophisticated than the average stock trader. In addition, large options traders are often professional, wealthy individuals or institutions, either of which could have unique insight or information about a company. Even traders that stick exclusively to stocks watch the option market closely for unusual trading activity as an indicator of where the “smart money” is focusing.

Unfortunately, because stock investors often use put options to hedge larger bullish stock positions, there’s no way to be 100% certain whether an option trade is a standalone purchase or a hedge against a stock position.

Given the relatively modest size of the two trades mentioned above by institutional standards, they were unlikely to be hedges in this instance.

What's Next

Trading interest rate hikes can be tricky business,even for the most experienced traders. Falling interest rates are historically good news for stocks, especially if rates are cut during periods of economic expansion. However, the market typically reacts to Fed moves relative to expectations. In that sense, the 0.25% rate cut on Wednesday seems to have actually disappointed investors hoping for a 0.5% cut.

The SPY traded lower following the news, despite the fact that interest rate cuts are typically good news for stocks. The Coca-Cola option trader bet on lower share prices ahead, despite the fact that high-yielding dividend stocks become more appealing to income investors as interest rates fall.

However, falling interest rates also pressure the net interest margins and earnings of big banks like Citigroup. Wednesday’s Citigroup put buyer may be betting Citigroup’s 36.5% year-to-date rally is looking a bit overdone given the potential difficult interest rate environment the company is now facing.

Related Links:

Federal Reserve Issues First Rate Cut In 11 Years

How To Read And Trade An Options Alert