FOMC Recap: Where Is Wall Street Betting?

In late November 2008, the Fed announced it would start purchasing mortgage backed securities. As of early January the Fed announced they had begun the purchasing of these securities. Below you can read yesterday's press release, which is taken directly from the Federal Reserve website:

For immediate release

Information received since the Federal Open Market Committee met in April suggests that the pace of economic contraction is slowing. Conditions in financial markets have generally improved in recent months. Household spending has shown further signs of stabilizing but remains constrained by ongoing job losses, lower housing wealth, and tight credit. Businesses are cutting back on fixed investment and staffing but appear to be making progress in bringing inventory stocks into better alignment with sales. Although economic activity is likely to remain weak for a time, the Committee continues to anticipate that policy actions to stabilize financial markets and institutions, fiscal and monetary stimulus, and market forces will contribute to a gradual resumption of sustainable economic growth in a context of price stability.

The prices of energy and other commodities have risen of late. However, substantial resource slack is likely to dampen cost pressures, and the Committee expects that inflation will remain subdued for some time.

In these circumstances, the Federal Reserve will employ all available tools to promote economic recovery and to preserve price stability. The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period. As previously announced, to provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve will purchase a total of up to $1.25 trillion of agency mortgage-backed securities and up to $200 billion of agency debt by the end of the year. In addition, the Federal Reserve will buy up to $300 billion of Treasury securities by autumn. The Committee will continue to evaluate the timing and overall amounts of its purchases of securities in light of the evolving economic outlook and conditions in financial markets. The Federal Reserve is monitoring the size and composition of its balance sheet and will make adjustments to its credit and liquidity programs as warranted.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Donald L. Kohn; Jeffrey M. Lacker; Dennis P. Lockhart; Daniel K. Tarullo; Kevin M. Warsh; and Janet L. Yellen.

As you can see, the Fed announced it would leave its quantitative easing programs steady. They reiterated to leave their target for purchasing mortgage-backed securities at $1.25 trillion.

Below I'll define what a mortgage-backed security is for those who don't know. The definition below is taken directly from the SEC website:

Mortgage-backed securities (MBS) are debt obligations that represent claims to the cash flows from pools of mortgage loans, most commonly on residential property. Mortgage loans are purchased from banks, mortgage companies, and other originators and then assembled into pools by a governmental, quasi-governmental, or private entity. The entity then issues securities that represent claims on the principal and interest payments made by borrowers on the loans in the pool, a process known as securitization.

Most MBSs are issued by the Government National Mortgage Association (Ginnie Mae), a U.S. government agency, or the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac), U.S. government-sponsored enterprises. Ginnie Mae, backed by the full faith and credit of the U.S. government, guarantees that investors receive timely payments. Fannie Mae and Freddie Mac also provide certain guarantees and, while not backed by the full faith and credit of the U.S. government, have special authority to borrow from the U.S. Treasury. Some private institutions, such as brokerage firms, banks, and homebuilders, also securitize mortgages, known as "private-label" mortgage securities.

Mortgage-backed securities exhibit a variety of structures. The most basic types are pass-through participation certificates, which entitle the holder to a pro-rata share of all principal and interest payments made on the pool of loan assets. More complicated MBSs, known as collaterized mortgage obligations or mortgage derivatives, may be designed to protect investors from or expose investors to various types of risk. An important risk with regard to residential mortgages involves prepayments, typically because homeowners refinance when interest rates fall. Absent protection, such prepayments would return principal to investors precisely when their options for reinvesting those funds may be relatively unattractive.

Wall Street Reaction

Within minutes of hearing this, three option contracts started lighting up my screen as most actives. The company is Annaly Capital Management (NLY) and they make money off the interest spreads on their large portfolio of mortgage backed securities. Call contract volume for Annaly started exploding for the July 14, July 13, and July 12 shortly after this announcement.

As of market close June 24, 2009, the two most traded contracts were for Annaly. The volume for the July 14 call contract was 728.949, and the July 13 was 145,216. Keep in mind this is on a volume of 14.4 million shares for the day. The volume change for the July 14 call contract was +728,771 or a 409421.9% increase. These contracts for Annaly had higher volume than the other 3 stocks/ETFs which made up the rest of the top 10 list, those stocks/ETF's were S&P 500 SPDR (SPY), NASDAQ 100 SPDR (QQQQ), and Citigroup (C).

It will be interesting to see what Annaly does by July contract expiration. Somebody is betting big on the near future of this company. As stated in my blog, I will monitor these calls as I may want to open a position myself.

Disclosure: No positions

Comments

[Alan Young:]

Anyone looking at the chart for NLY today may be confused by the island it just dropped out of. That was the dividend-capture trade; it went ex-div today for a $.60/share difference in value.

Jun 25 10:36 AM