U.S. equity markets have reversed course (favoring the bulls) in the month of May and once again look to establish new all-time highs. I credit the heavy hand of the Federal Reserve who synthetically cut interest rates by “slowing the pace” of their balance sheet reduction. The S & P 500 has risen nearly 10% in 2024 and has racked up twenty-two new all-time highs. Since I believe that this recent Fed-induced rally will stall, I want to be positioned to capture another potential pullback (even if shallow again). .SPX YTD mountain S & P 500 YTD Back in April, investors had very little interest in a string of U.S. Treasury auctions resulting in yields surging with the 10-year rate jumping to 4.7%. The Fed quietly pivoted and covertly intervened by reducing the current run-off rate of their massive Treasury positions on their $7.5 trillion balance sheet. As the Fed tries to reel in their enormous balance sheet expansion implemented during the Covid pandemic, they clearly felt compelled to create “demand” in future U.S. Treasury auctions as they still have a ton of debt to sell in 2024. Our government is poised to sell another $386 billion just in May. US10Y YTD mountain 10-year Treasury yield, YTD With the current surprising hotter-than-expected first quarter inflationary data and also being inside of an election year, I believe the Fed wants to continue to be perceived as independent. Cutting interest rates without obtaining their 2% inflationary target coupled with equities at all-time highs might be perceived by the marketplace as a political move. In addition, an actual interest rate cut could create questions about the economic outlook, causing market participants to take profits and apply pressure to equity prices. The trade As I believe we will continue to trade in the 4800-5300 range on the S & P 500 , I want to establish a position which seeks to capitalize in the event we do see an about face in equity prices. Selling a Risk Reversal in SPDR S & P 500 ETF Trust (SPY) : Sold $540 6/07/2024 call for $1.15 Bought the $500 6/07/2024 $500 put for $1.05 This was traded with underlying SPY trading roughly $522 This risk reversal collected $0.10 or $10 for every one lot This is important to understand that the upside $540 call is naked. In the event you have long exposure to the S & P 500, this short call will serve as a hedge to that long exposure. If this is simply a trade, that upside call will need to be managed. I remain optimistic on the equity market in 2024 but, I believe the CBOE Volatility Index at 12 reveals complacency short-term. DISCLOSURES: (Long SPY and this trade.) THE ABOVE CONTENT IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY . THIS CONTENT IS PROVIDED FOR INFORMATIONAL PURPOSES ONLY AND DOES NOT CONSITUTE FINANCIAL, INVESTMENT, TAX OR LEGAL ADVICE OR A RECOMMENDATION TO BUY ANY SECURITY OR OTHER FINANCIAL ASSET. THE CONTENT IS GENERAL IN NATURE AND DOES NOT REFLECT ANY INDIVIDUAL’S UNIQUE PERSONAL CIRCUMSTANCES. THE ABOVE CONTENT MIGHT NOT BE SUITABLE FOR YOUR PARTICULAR CIRCUMSTANCES. BEFORE MAKING ANY FINANCIAL DECISIONS, YOU SHOULD STRONGLY CONSIDER SEEKING ADVICE FROM YOUR OWN FINANCIAL OR INVESTMENT ADVISOR. Click here for the full disclaimer.
A market hedge for traders if you believe this May comeback is a head fake
May 10, 2024
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