How to Trade Today's Fed Announcement
NEW YORK ( TheStreet) -- Too often I see aspiring traders trying to make money by "guessing" how the market will react on events. Today's Federal Reserve announcement and Chairman Ben Bernanke's press conference is a prime example.
People are positioned long or short based on their views of what they "think" is going to happen today. As we all know, markets can become irrational, and even when the anticipated announcement is released, the markets do not react the way we "think" they should.
This is a huge trap for traders, and a difficult habit to overcome. No one has a crystal ball -- all we can do is see what the market does. What matters -- and determines our success -- is what we do when it gets to wherever it's going to go. In other words, the market is always right.
Trying to position a trade ahead of this announcement is a crapshoot. Our job as traders and brokers is always to try to keep the odds tilted in our favor as much as possible. One way we can accomplish that is by taking a non-directional standpoint in today's trade rather than a directional standpoint.One opportunity we have looked at, and like, is in the gold futures market. Gold has clearly broken out to the upside after trading in a range from $1,540-$1,640 for several months. (I am looking at the December futures contract.) The breakout has been strong -- it has shown good volume, pullbacks have been shallow, and one could certainly argue that the fundamentals are in place for sharply higher prices. Now, back to the crapshoot today. Implied volatility in gold options is quite high right now. Currently, gold options are trading with an implied volatility of 18.1%, which is in the 99th percentile of the past 60 days. For those who aren't option savvy, what this means is that players in gold options are pricing in a very large move and a lot of volatility. Statistical volatility for the same period has only been 12.6%. In other words, the market is pricing in larger moves than it has previously. As we all know, the herd is usually wrong. In my professional opinion, these options are now strongly overvalued and present a good premium selling opportunity. Because I prefer defined risk spreads, we will look to use an iron condor spread to attempt to capture what we feel is excessive option premiums. Strikes can vary based on an individual's risk tolerance and preferences. We will use November options, which are based on the December futures contract. The November options have 43 days until expiration. We feel that 40 to 50 days from expiration tends to be the sweet spot for selling option premiums. As an option approaches expiration, time decay accelerates exponentially. This time frame seems to maximize the trade potential while keeping the clock working strongly for us rather than against us. Along with time decay, however, and perhaps even more importantly, we will be looking for implied volatility to "implode" today. In other words, once the announcement is out, the degree of uncertainty is minimized. This, we believe, will cause option premiums to deflate quite rapidly. So if we sell options when they are expensive, and buy them back when they are cheaper, we can potentially produce a profit. Instead of buying low and selling high, we are selling high and buying low. They both accomplish the same end. Here is one way to play today's news from a non-directional standpoint using the gold market: As always, feel free to email me to discuss other opportunities. Note that today is Thursday, Sept. 13, and the trade is based on the most recent data. Sell 1 November Gold 1,850/1,890 call spread and sell 1 November gold 1,600/1,640 put spread, creating the iron condor spread. Work a limit order to sell this four-way position at a credit of $950 or better before today's Fed announcement. Target: Look to buy this spread back, thus closing out the position for $400 or less. Risk on trade: As stated above, risk is $2,970 including round-turn commissions of $20 inclusive of all fees. (Remember, there are four contracts involved in this spread, thus four sets of commissions and fees.) Profit potential: Limited to the premium collected minus commissions and fees. As stated above, profit would be $470 after subtracting a R/T commission of $20 inclusive of all fees if position is bought back for $400. If held to expiration, profit would be $870 after subtracting a R/T commission of $20 per contract inclusive of all fees. Please note: Futures and options trading is inherently risky and isn't suitable for all investors. Past performance isn't indicative of future results. Stop-loss orders meant to limit losses may not be effective because market conditions may make it impossible to execute such orders.
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