Traders’ eyes are fixed on the Federal Reserve today as Janet Yellen and crew unleash yet another Federal Open Market Committee (FOMC) announcement. The market expects the monetary maven to keep the Fed funds rate as-is, but as usual the devil’s in the details.
Fed watchers everywhere will be parsing the language of their statement for clues regarding future policy decisions.
Expect sleepy markets ahead of the FOMC announcement with volatile fits and starts following it. If you’re fearful the Fed may single-handedly sabotage the glorious rally that has transpired in stock land, it’s high time to grab a hedge for your portfolio.
Or, really, today’s trade idea could be a standalone bearish play poised to profit should the market throw a tantrum following this afternoon’s FOMC announcement.
To exploit a broad market rollover, we can use the popular iShares Russell 2000 Index (ETF) (IWM), which tracks small-cap stocks. Compared to the other broad indices, IWM has been noticeably weaker in recent months. While the S&P 500 has recovered close to its prior highs, IWM remains a far cry from its 2015 peak.
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And with its weekly trend still pointing lower, the recent rally is looking more and more like a shorting opportunity. If traders decide to jettison risk from their portfolios following this afternoon’s Fed commentary expect the smaller-cap stocks to bear the brunt of the damage. That’s no bueno for IWM.
Hedge the Federal Reserve With an IWM Put Spread
Buying put spreads is one of the most efficient (not to mention low-cost) ways to grab some protection ahead of the Fed. With IWM perched at $106, you could buy the Apr $106/$101 put spread for $1.56. The $5-wide bear put spread is well positioned to thrive should IWM tumble to $101 over the next few weeks.
The max risk is limited to the $1.56 debit and will be forfeited if IWM sits above $106 at expiration. Though, if you’re looking to minimize the loss, I suggest bailing if IWM breaks above its recent highs of $109.
The max reward is limited to the distance between strikes minus the net debit, or $3.44, and will be captured if IWM can fall below $101 by expiration.
As of this writing, Tyler Craig did not hold a position in any of the aforementioned securities.
