Today the FOMC will decide whether not to raise the federal funds rate – it’s most landmark policy decision since 2 years ago (nearly to the day), when it announced it would taper the controversial bond buyback program.
The possible rate hike from 25 to 50 basis points, allegedly been priced into stocks since mid-year, has inflated volatility to levels probably not seen since the last Fiscal Cliff…
Actual tightening by the Fed can only strengthen the dollar and create headwind for a possible rally in crude. While the commodity may find a near-term bottom around $30 (if it hadn’t already), I believe oil will see $20 before it sees $50 again (if ever).
With expiry week further jam-packing this week’s powder keg of volatility, let’s break down the straddles:
SPY Dec15 203 Straddle is 5.30 [2.6% implied move]
VXX Dec15 21.5 Straddle is 2.70 [12.6% I.M.]
USO Dec15 11 Straddle is 0.70 [6.3% I.M.]
XLF Dec15 23.5 Straddle is 0.80 [3.4% I.M.]
Oh yeah, and RSX Dec15 15 Straddle is 0.70 [4.7% I.M.].
For a direct short volatility play, less experienced traders (and ones with higher commissions] could can short-sell VXX outright or buy put spreads. Nothing the Fed announces on Wednesday is going to significantly impact crude, and I expect to see some stabilization until early to mid January.
I like selling the USO straddle and adding protective wings to form an Iron Butterfly.
My Trade: Sell the USO Dec15 10.5-11-11.5 Iron Butterfly for $0.38 Net Credit
Risk: $12 per 1 lot
Reward: $38 per 1 lot
Break-even [share price at expiration]: 10.62 and 11.38
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