Case Study On Economic Analysis : Fed Rate Hike Or Interest Rate Hike

A lot of the articles here are informational and may be theory. To make this site different from other sites, we decided to incorporate not just the strategies themselves but also real life case studies that can help an options trader over the long term. At the time of this writing, there was an announcement on a Fed Rate Hike.

This means that the Fed has announced that it was going to increase interest rates. The interest rate, as mentioned in other articles, the cost of borrowing money. When the cost of borrowing money is low, there tends to be an economic expansion. When the cost of borrowing money is high, there tends to be an economic contraction.

The announcement made recently sent the market spiralling downwards. These were the headlines on www.marketwatch.com .

Source : www.marketwatch.com

When the Fed announced plans to increased interest rates from 1.25% to 1.5%, this meant that consumers and businesses had to pay more in interest expenses. So this is how it works. The fed increases the fed rate. Banks that borrow from the fed will have to pay more in interest expenses. As a result, loans such as home loans and credit card loans will see a much higher interest rate than before.

If you were an options trader at this point, what would you do?

More likely than not, consumer spending as a whole is going to be affected. Businesses are going to be affected. And as such, the economy as a whole will contract. But even before there is a tangible contraction in the economy, the markets will react.

The effect is this. The Dow Jones has fallen from more than 26000 points to less than 25000 points in just the first two months of 2018.

What is an options trader or an investor to do then? If there are any long stock positions in stock, a trader can write covered calls to reduce the breakeven price or write puts to acquires more stock at lower prices. Or if he is adventurous and convinced that we are heading into a recession, he may want to short the market on buy puts on certain companies that he feels will be greatly affected by the interest rate hike.

Regardless of the course of action to take, the trader or the investor employing options must have a view as to what will happen to the general economy or the stock market. That view, if correct, can help the trader or investor to reap big profits.

For more, read : Basic Economic Analysis