Federal Reserve's Rate Decision and the Surge in 0DTE Trading

01-11-2023

Fed Interest Rate Decision

It is widely anticipated that the Federal Reserve is to maintain its interest rates within the 5.25% to 5.5% bracket when it meets today.

There has been a substantial increase in the yield of the 10-year U.S. Treasury Bond in recent weeks. At the time of the Federal Reserve’s meeting in September 2023, the yield was positioned at 4.5%, but it has since escalated to approximately 4.9%. This substantial rise in a key fixed income benchmark has led the Fed to contend that the increase in longer-term rates has significantly contributed to the tightening of monetary policy. Fed officials have equated this shift in rates to an additional interest rate hike.

Recent economic data appears to be quite promising. Core inflation has been on a downward trend. For September 2023, the annual rate of core PCE inflation was recorded at 3.7%, continuing the disinflation trend observed throughout the year. Additionally, while the job market remains robust, there has been a noticeable shift towards a more balanced relationship between supply and demand, with a deceleration in wage growth.

0DTE Trading:

Zero days to expiration options, or 0DTE options for short, are options contracts that expire and become void the same day that they’re traded. When an option reaches this stage, there’s not much more time left to act on the right to buy or sell the underlying asset. The window is small, and the move that the trader is plotting needs to happen fast.

0DTE options trading has entered the mainstream in recent years and is a popular premium-collecting strategy.

Some Traders find the final trading day before an option’s expiration to be the prime time to engage in options trading. The appeal of 0DTE options lies in their capacity to provide a rapid turnaround, enabling traders to swiftly realise gains or losses while only temporarily allocating their capital. This same-day trading approach also has the added benefit of sidestepping the potential risks associated with overnight price fluctuations, which can occur when the market is closed, and the trader is unable to monitor or respond to changes in real time.

0DTE trading tends to be especially favoured among option sellers. Numerous individuals ardently advocate for this approach, asserting that it presents an opportunity to achieve substantial profits with minimal exposure to risk. They emphasise the potential benefits of selling options that are set to expire within a single day.

Short-dated options in general offer investors inexpensive ways to express a short-term view to complement a longer-term strategy, to hedge a portfolio or to trade tactically around events, such as a Federal Reserve meeting. A common strategy is to sell these short-dated options to harvest the premium (i.e., assuming some level of market risk in exchange for premium) as the day goes on. Typically, the value of the at-the-money option decreases as the day goes on (keeping in mind the option that is at-the-money changes as the index level changes).

Trade Idea – Iron Condor

The iron condor is designed to profit in two ways, if the market were to trade sideways and the underlying expires between the sold legs of your strategy all options expire worthless and the credit received, being your maximum profit, is kept. This strategy is designed to profit from the market moving sideways.

The second is from a decline in implied volatility levels, in which case the options may also lose value meaning you can buy back the short condor for less than you sold it for.

This is a neutral strategy that benefits from a minimal movement in the underlying as well as implied volatility levels decreasing. Executing this trade consists of selling a call spread and selling a put spread. All four legs of the strategy will have the same expiration date.

The consensus amongst analysts is that the US Federal Reserve is likely to keep interest rates unchanged on Wednesday 1st November.