Fed’s Bowman, who often disagrees with the Federal Reserve’s views, did not discuss monetary policy or the economy in her recent speech. We might gain more insights during a Q&A session later. U.S. stock indices are trending upward before the market opens, although not at their highest levels. The NASDAQ is up by 183 points, boosted by Nvidia shares, which are set to hit a record level after getting approval to sell chips to China. The S&P index is also gaining, up 33 points.

Silence as a Signal

Bowman’s silence speaks volumes. When someone known for dissent keeps quiet on policy matters, it often indicates that there are heated discussions happening at the Fed. Previous comments from Waller suggest that there might be adjustments this summer, adding to the overall uncertainty. This isn’t a time for passive trading; it’s time to take advantage of the volatility that comes with such uncertainty. The Cboe Volatility Index, known as the “fear gauge,” has been stuck around 13, which is much lower than the long-term average of about 19. The low implied volatility paired with real policy uncertainty from the Fed presents a clear chance for traders. We think that options for protection or volatility are underpriced. Buying long-dated VIX calls or puts on the SPDR S&P 500 ETF (SPY) makes sense as a hedge against the market realizing that the future may not be as smooth as current prices suggest. At the same time, we must recognize the strength of the tech sector. This rally is mainly driven by a small group of stocks. Recent data shows that, without the top 10 largest companies, the S&P 500’s earnings growth for the first quarter would have been negative. This isn’t a broad bull market; it’s a few stocks on a rocket, with news about chip sales to China adding more fuel to their ascent.

Dynamic for Derivatives

This creates an interesting situation for derivatives. We are preparing for a rise in divergence. We are considering strategies like long call options on the Invesco QQQ Trust, which follows the Nasdaq 100, while also buying put options on an equal-weighted S&P 500 ETF like Invesco’s RSP. This strategy bets on the tech giants continuing to rise, while the other 490+ companies in the S&P 500 may struggle due to a slowing economy—the very reason Waller and his colleagues might consider a rate cut. Looking back, the time just before the first Fed rate cut in a cycle is usually volatile. Markets may initially cheer the “Fed pivot” but later face the economic weaknesses that prompted the Fed’s decision. The current futures market shows more than a 60% chance of a rate cut by September, according to the CME FedWatch Tool. This means we have limited time. We are using options to bet that the market’s initial excitement over potential rate cuts will soon give way to a more realistic assessment of why those cuts are necessary. Create your live VT Markets account and start trading now.

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