FED COULD DELIVER A SUMMER BUMMER / BARRON´S

Tuesday, August 11, 2009

THE STRIKING PRICE DAILY

Fed Could Deliver a Summer Bummer

By STEVEN M. SEARS

VIX options are active on fears of an interest-rate hike Wednesday.

IN WASHINGTON, THE Federal Reserve's interest-rate-setting committee today begins a two-day meeting that some investors think may precede a rate hike.

Along the beaches of the Eastern seaboard, traders, portfolio managers and institutional investors are starting to enjoy their traditional week or two of summer vacation.

Into this void of time and space, a growing number of call options on the Chicago Board Options Exchange's Market Volatility Index (VIX) continue to amass just in case something happens to disrupt the overbought calm that now defines the Standard & Poor's 500 index.

It seems difficult to imagine that the Federal Open Market Committee will actually increase interest rates, as some quietly fret, because higher rates could squelch the U.S. economy's nascent growth. Still, the U.S. dollar strengthened Monday, and traders know the greenback's relationship with U.S. stock is often inverse.

The crowd may disagree on all the reasons why the U.S. dollar strengthened, and why it had mixed impact on gold, soybeans and oil, but it is a fact that options volatility has returned to the precrisis levels in the days before Lehman Brothers declared bankruptcy. Another fact is that the S&P 500 index is incredibly "overbought." It doesn't take a technician to realize that the uninterrupted surge in equity prices since March has to ebb.

So the prudent trade, the crowd says, is strategically buying VIX options volatility in case near-term market events disrupt the end-of-year volatility trades. The VIX call buying is the exception to a trend in the options market of selling puts and calls in anticipation of further volatility declines.

The VIX was recently up about 5%, edging above 26.

Until Wednesday's announcement from the Fed, do kick back. Try to relax as the market stays in a holding pattern.