March Fed Minutes Show Potential Future POMO Changes


The March Fed minutes (released before market open this morning) revealed some of the evolving discussion regarding the future of the current $85 billion / month Treasury / MBS Quantitative Easing program. We see some of the changes in thinking about the future direction of the purchase commitments to impact the overall market starting in Q2 potentially if the language we saw this morning remains the same.

What Was Said That Matters RE: Fed POMO

The most important language in the Fed Minutes revolved around the discussion about the future continuation (existance and size) of the current Treasury and Mortgage bond purchase programs. The discussion has centered around the possible slow-down or discontinuation of the program beginning sometime after the second quarter of 2013. As we have repeatedly mentioned, the discontinuation of cash injections into the stock market will have a pronounced negative impact on the stock price levels. What we may have failed to emphasize in the past is that the expectation that QE will be discontinued will signal a sharp downfall in the stock-market – as leveraged buyers quickly reign-in positions in anticipation of price declines.

But The Current Expectation Is Program Slowdown in Q3 or Later

As the Fed Minutes reveal, the current discussion talks about potentially winding down the program beginning in Q3 – so why the need to be prepared now? Obviously once the Fed changes the language from a discussion level of program direction to a firm commitment to winding down the program the impact on stock prices will be immediate. For my own perspective, this is the signal I have been looking for as to start picking long-dated out of the money put options to buy for my portfolio. I have no plans to initiate any positions in the next 72 hours, however I wanted to share my strategic thoughts with my long-time readers so that they might be starting their own research into the matter.

Intro to Put Options (video)

Why Use Long-Dated Out of the Money Option Contracts?

See demo

One of the most important aspects of options trading is making the most effective use of capital. When trying to make small cash investments pay off big you have to be able to effectively understand and use leverage. Long-dated put option contracts are likely to be fairly pricey, so in order to get more bang for the buck we pick out of the money contracts (hopefully with some modest volume) on one of the major indexes – which reduces the put-premium. Here’s a quick video on the relationship between option contract premiums and implied leverage. It’s up to you to do your own thinking on which indexes to target and which contracts to buy (and of course follow the Fed minutes either here or in the news closely for important changes in language).

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Relationship Between Options Premiums (Price) and Implied Leverage (video)

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