Stocks Traders Eyeing Fed Pause Hedge Rally With Call Options

(Bloomberg) — Investors are loading up on call options as they brace for a pivotal Federal Reserve decision that’s set to dictate the tone for equities heading into the second half of 2023.

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Options trading on US exchanges at one point last week showed the biggest bias toward calls in 14 months, data compiled by Bloomberg show. Using calls lets investors capture the upside if the bull market proves resilient, while still remaining defensive because they’re wary of what the Fed might signal this week about its policy path.

The central bank is expected to pause its tightening on Wednesday for the first time in 15 months. The risk, however, is that a resilient economy keeps the inflation rate stubbornly high, pushing officials to hike again as soon as next month or keep borrowing costs elevated for longer. That could weigh on the rate-sensitive Big Tech stocks that have been key to the market’s gains.

It all makes this Fed decision and Chair Jerome Powell’s subsequent remarks critical as investors position for the rest of the year. Tuesday’s consumer price index reading takes on added significance, too, as signs of ebbing inflation could buoy shares, including areas like banks and small caps that are closely tied to the health of the economy.

“There’s always going to be a wall of worry, but the stock market historically sees better times ahead before the economy does,” said Quincy Krosby, chief global strategist at LPL Financial. “If we see more interest in small caps and financials, it will be a telling sign that investors are more comfortable about where the economy is headed.”

With the S&P 500 hovering around 4,300 — roughly its peak for the second half of 2022, reached in August — traders are turning to cheap call options. These contracts give the right but not the obligation to buy an underlying asset at a specified price within a set timeframe.

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They’re likely doing that while simultaneously selling the underlying securities, according to Brian Donlin, head of equity derivatives strategy at Stifel…


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