Options Plays Ahead of FOMC Rate Decision

Today, attention is on the FOMC policy decision .

The CME FedWatch Tool shows a 99% chance the Fed will keep rates at 4.25%-4.5%, following stronger-than-expected April jobs data. While no rate change is expected, markets will react to Powell’s comments on two key issues: managing inflation risks from tariffs and signs of economic slowing.

Powell faces a tough choice. If he sounds too dovish (leaning toward rate cuts), it might fail to control inflation from new tariffs. If too hawkish (keeping rates high), it could hurt economic growth. Nick Timiraos, a well-known Fed reporter, notes the central bank risks causing either a recession or stubborn inflation no matter what it does.

Bloomberg analysts expect Powell to focus on fighting inflation, while others warn he may push back against claims that the White House influences Fed decisions. This could reignite tensions with former President Trump, who recently criticized Powell on social media that He’s always late and wrong!

An analysis team led by Michael Gapen, Chief U.S. Economist at Morgan Stanley, wrote in a recent report, given firm inflation expectations and the potential for persistent inflation effects from tariffs, the Fed is unlikely to take preemptive action.

Trump vs Powell: Why Markets Care

In the past month, the conflict between Trump and Powell has worried investors as it questions the Fed's independence.

On April 4, 2025, the $S&P 500 Index (.SPX.US)$ fell over 6% on Tariff Liberation Day, and Powell stated that the Fed is not in a hurry to respond to tariffs.

In a speech on April 16, Powell reiterated his stance that tariffs are likely to lead to a temporary increase in inflation at least. Currently, we have the ability to wait for clearer signals before considering adjusting our policy stance. The stock market fell again that day, with the $S&P 500 Index (.SPX.US)$ dropping 2.2%.

On April 17, the day after Powell's speech at the Chicago Economic Club, Trump criticized the Fed Chairman on Truth Social that the European Central Bank is expected to cut rates for the seventh time, yet, 'too late' Jerome Powell from the Fed, who is always late and wrong, released a report yesterday, another typical, complete 'mess'! Powell's dismissal can't come soon enough!

In the following days, Trump even told reporters that if I want him gone, he’ll be out of there quickly, trust me. The S&P 500 fell about 2.4% on the day Trump made these remarks to reporters.

After April 21, the $S&P 500 Index (.SPX.US)$ rose for nine consecutive days, the longest streak in over 20 years. This was partly due to progress in trade talks, but analysts say Trump's softening stance on Powell also played a role.

Trump retracting his comments about Powell may have reassured investors, making them feel that Trump is actually listening to the market. This rebound directly leads to the next Fed meeting.

Analyst Sosnick said, "Clearly, the recent significant rise in the stock market largely reflects market optimism about Powell's possible remarks. Otherwise, such a rebound wouldn't occur."

However, this optimism may be somewhat unrealistic. According to the CME FedWatch Tool, the market currently estimates a 99% probability that the Fed will keep the target rate unchanged at the May meeting, but it also expects three rate cuts by the end of 2025.

If the Fed doesn't cut rates in May, investors might pay attention to whether Powell mentions a rate cut in June. However, if the Fed wants to wait for the impact of tariffs to show, it might wait until the current 90-day tariff pause ends in July, further delaying rate cuts.

Options Plays for Powell's Speech

Overall, the market leans towards expecting Powell to be hawkish to stabilize inflation expectations. Powell needs to balance the dual pressures of Trump's tariff policy raising inflation and slowing economic growth but should be cautious of suppressing market sentiment.

If Powell hints that tariff impacts are limited or "the economy lacks resilience and needs a rate cut," it might trigger a stock market rebound, though the probability is low. 

Looking at the options data for the $S&P 500 Index (.SPX.US)$ , the current implied volatility has dropped to 23.01%, with an implied volatility rank of 32.

The $CBOE Volatility S&P 500 Index (.VIX.US)$ is currently at 24.62, returning to levels seen before Trump's tariff announcement on April 2.

Overall, the current options for the $S&P 500 Index (.SPX.US)$ show that the market is pricing in relatively low volatility following the interest rate decision. However, if actual volatility exceeds expectations, there are still trading opportunities.

Short-term Strategies:

1. Long Straddle: Bet on significant market movements.

– Action: Buy both call and put options with the same expiration date and strike price (e.g., S&P 500 with a strike price at 5650).

– Logic: Bet on that Powell's speech will cause significant market volatility (in either direction), covering the possibility of breaking through support (5300) and resistance (5700).

– Risk: With high volatility, the cost of premiums is high, requiring the movement to exceed the breakeven point (more than a 2% daily move in the S&P).

2. Bear Put Spread: Bet on a moderate market decline, reducing premium costs, with a controlled risk-reward ratio.

– Action: Buy a put option (e.g., S&P 500 at 5700) and sell a lower strike put option (e.g., S&P 500 at 5500).

– Logic: Costs less than a straddle, suitable for expected volatile scenarios, needing the market to break recent trading ranges.

– Risk: If the market trades within a narrow range, time value decay can be significant.

3. Protective Put: Hold long positions in index ETFs or component stocks while buying out-of-the-money put options (e.g., S&P 500 at 5500 ) to hedge against potential declines from hawkish remarks, while retaining upside potential, suitable for short-term risk management for position holders.

1. Investors need to closely watch Powell's wording on inflation expectation management and tariff impacts. If unexpected signals are released, adjust strategy directions promptly. Historical data shows that after hawkish Fed remarks, the $S&P 500 Index (.SPX.US)$ can drop by 2%-3% in a single day.

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