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Why the Fed Raised the Discount Rate

|Includes: SPDR S&P 500 Trust ETF (SPY)

The Federal Reserve RAISED the discount rate by .25 point after the bell today. While many have been looking for the Fed to signal that it was raising rates, the timing of this announcement seems odd, at first. Here are my thoughts, the Fed is looking for shock value and wanted to make a statement. Basically they are saying “We are watching inflation, despite this bloated budget, we will not continue to pump money into this system forever.” Expect the fed fund futures to price in 100% of a .25 raise tomorrow along with somewhere in the range of 25-50% chance of a .50 point increase at the next meeting. This should also help those planning a trip to Europe in the next few days as the dollar will likely rally. I do not disagree with the Fed raising rates, in fact I understand the approach to this announcement (shock the market, make a statement, and remind the world the Fed is credible). Understanding does not mean I agree with the approach. It is never a great idea to give an unexpected jolt to the market.

As far as options go, this is reason number 15,000 that traders should not go out expiration straddles in the major indexes. The 1105 straddle went out around 6.50. Futures are down 10.50 right now, that 1105 straddle is going to be a HUGE loser! As far as the general market goes, I think this is a clear sign the Fed thinks the banks are in somewhat better shape. It also states that the Fed is bullish the economy (somewhat). The market may sell off on this news (currently ES futures are down about 10 handles). I could see the market opening down quite a big, possibly as much as 15 handles. However, I would not be shocked if we rallied in the afternoon. Even if the market sells off over all day I do not see this as a something that pushes the market into a long term correction. In fact, tomorrow may end up being a great day to either sell volatility, or trade some sort of volatility duration play (calendar, double diagonal, double calendar). I want to get net short weighted vega, caring less about being long raw vega, possibly even preferring to be long raw vega. I am thinking the high of the VIX will be in the morning, probably up about 2 points, if the SPX is down around 12 points.



Disclosure: I have an SPX option position on