With the Federal Reserve likely to raise interest rates next week, the market could rally on a rate hike. Most of the suits-and-ties have said that the market will tumble once the Fed starts to raise rates, but I have been telling my Momentum Options members that the financial stocks need to lead the next rally to higher highs.

The Financial Select Sector SPDR Fund (XLF), an ETF of financial stocks, has mirrored the indices, as it has traded in a $1.50 range between $23.50 and $25 since mid-October. The financial stocks have held their 100- and 200-day moving averages for the most part over this time period, and the 50-day moving average is in a solid uptrend. A golden cross is imminent on a move above $25. A close below $23.50 and the 50-day moving average would negate the bullish setup.

Investors could trade options on the XLF to play the next major move, but they aren’t as liquid as some of the individual banking stocks. For instance, the XLF December 24.50 calls (XLF151218C00024500) rocketed more than 200% higher on Friday, but volume was less than 600 contracts.

I like the XLF January 25 calls (XLF160115C00025000) as a possible trade if XLF shares clear $25. Volume in these contracts was more than 2,500, with open interest above 200,000 contracts.

In comparison, Bank of America (BAC) shares are in a bullish setup, as a golden cross officially formed in late November. I have the BAC January 18 calls (BAC160115C00018000) on my watch list to play a move past $18 and possibly to $20 by mid-January. These call options traded more than 47,000 contracts on Friday, and open interest is more than 250,000 contracts.

The Federal Reserve will meet next week, and a decision on interest rates is expected on Dec. 16. Fed Chair Janet Yellen said the process of rate increases would be gradual, but she failed to specify what gradual means in terms of specific timing.

Wall Street has penciled in nearly an 80% chance that the Fed will raise rates this month, and a 50% chance for a second rate hike by March. Looking even further out, the median forecast for the fed funds rate for mid-2016 is 0.75%, and it is 1.125% for the end of next year.

The Fed has been reluctant to tighten policy twice this year, in June and September, so the possibility that it will keep rates unchanged does exist. Odds greatly favor a rate increase, but there is still a 20% chance that the Fed will stand pat. If it elects not to increase rates, I would imagine a selloff would follow, as the market would likely be disappointed by the continued uncertainty.

This week could bring additional volatility, as most traders are unlikely to go long or short until the Fed news is announced.

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