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The biggest event of the week is undoubtedly the Federal Reserve's interest rate decision announced at 2:00 AM Beijing time on September 18, followed by Chairman Powell’s speech at 2:30 AM!

The market widely anticipates that the Federal Reserve will cut rates by 25 basis points to a range of 4%-4.25% in this meeting (with CME FedWatch showing a probability exceeding 90%). There is also a small chance of a 50-basis-point cut to 3.75%-4%. Thus, a rate cut of at least 25 basis points appears almost certain.

As for the expectation of a 25-basis-point rate cut, the market has already priced it in well in advance. Capital has been flowing into the market, pushing asset prices to elevated levels. Both the S&P 500 and Nasdaq indices are near historical highs, with the Nasdaq 100 hitting a new record last Friday and recording its longest consecutive upward streak in over a year.

What lies ahead? Opinions remain divided regarding the future trajectory of rate cuts. Some institutions predict three additional rate cuts by the end of the year, potentially extending into next year, suggesting the Fed may adopt a relatively cautious but sustained easing cycle. Others argue that while the short-term pressure of 'stagnation' outweighs 'inflation,' rising inflation could increase the threshold for further rate cuts, making economic stagnation risks worth monitoring.

Based on this background information, let us discuss: What should be expected after this meeting? What should investors focus on, and what stock or options strategies should they consider?

If rate cuts have been priced in beforehand, what should be the focus now?

Compared to the rate cut itself, hints about the future rate-cut path from the dot plot and Powell’s speech, as well as descriptions of the prospects for a soft landing or recession risks, may be more important. The following scenarios are analyzed:

1. A 25-basis-point rate cut coupled with a cautious statement and dot plot: This scenario has a higher probability. Since it has already been priced in, the market might fall into a 'buy the rumor, sell the fact' pattern afterwards, potentially triggering profit-taking and causing market volatility.

2. A 25-basis-point rate cut accompanied by a dovish statement or a relatively accommodative dot plot: There is some probability of this happening. In this case, technology stocks may lead the market to continue its upward trend.

3. A 50-basis-point rate cut combined with an unexpectedly accommodative statement or dot plot: This scenario has a lower probability. It could trigger significant market fluctuations, such as an initial surge followed by a pullback due to concerns over economic prospects, creating a roller-coaster effect.

4. A hawkish stance with less-than-expected rate cuts: This scenario also has a lower probability. Under these circumstances, the market would likely experience a rapid and sharp correction, with technology stocks possibly seeing even larger declines.

In summary, if the outcome is relatively conservative, a post-positive adjustment may follow; if the result is as expected but includes a small surprise, U.S. stocks may see another round of gains; and if there is a major unexpected event, including either no rate cut or a 50-basis-point cut, it will cause significant market volatility.

Looking further ahead, historical experience suggests the following: If the rate cuts are precautionary and the economy achieves a soft landing, U.S. stocks, after short-term fluctuations, often perform well in the medium to long term. However, if the rate cuts are recession-driven, even substantial cuts may not prevent U.S. stocks from experiencing difficulties due to economic recession and declining earnings.

Some people may not fully understand what precautionary rate cuts, recession-driven rate cuts, and a soft landing mean, so here is a brief explanation.

A soft landing means smoothly applying the brakes without a jolt—addressing the issue of the economy moving too fast or too slow while avoiding a stumble.

A preventive rate cut is akin to receiving a vaccine before falling ill, aiming to achieve a soft economic landing. This typically occurs when the economy shows signs of slowing but has not yet entered a recession, as seen in 1995 and 2019.

A recessionary rate cut represents 'administering strong medicine for a severe illness,' indicating that a soft landing has not been achieved and the economy has already faltered. This usually happens during an economic or financial crisis, such as the bursting of the dot-com bubble in 2001 and the global financial tsunami in 2007.

Regarding this rate cut, the market consensus broadly categorizes it as a preventive measure. Although employment data over the past year has undergone significant downward revisions, the unemployment rate remains at 4.3%, below the recession threshold of 5%. Core CPI stands at 3.11%, still above the inflation target but having retreated from its peak, while GDP continues to show positive growth.

Thus, the current situation resembles an intervention during a suboptimal health state, somewhat similar to conditions in 2019. However, current market valuations are higher, inflationary pressures are greater, and policy room for error is smaller.

Historical experiences with preventive rate cuts indicate the following:

Typically, one month after a rate cut, market volatility increases, potentially due to profit-taking after positive news or further confirmation of economic concerns. The average market performance tends to be negative during this period, making certain safe-haven assets worth monitoring.

Three to six months after a rate cut, markets gradually digest the information, and average returns begin to turn positive. At this stage, interest-rate-sensitive sectors such as technology growth stocks and real estate may benefit more significantly.

Twelve months after a rate cut, if the economy avoids a recession, U.S. equities typically deliver solid positive returns, averaging a 13% increase. Growth-oriented sectors like finance and discretionary consumption may attract particular attention.

However, excessive optimism should be avoided. Continued vigilance is necessary to assess whether the economy can achieve a soft landing, particularly by closely monitoring changes in inflation and employment data. If economic indicators suggest escalating recession risks, the nature of the rate cut could shift. In such cases, risk aversion and seeking certainty become paramount, with sectors like government bonds, gold, consumer staples, utilities, and healthcare likely gaining favor among investors.

Therefore, in the current market environment, which is abundant with opportunities but also harbors risks, it is crucial to adopt a strategic approach—seizing short-term opportunities while maintaining a long-term perspective.

The question that investors are most concerned about now is: what should be done at this stage?

The current market volatility exhibits an unusual level of subdued activity, $SPDR S&P 500 ETF(SPY.US)$ and $Invesco QQQ Trust(QQQ.US)$ with IVs being at historically low levels. However, this situation has created a window of opportunity for options buyers. (*IV represents the market's expectation of the range of stock price fluctuations over a certain period in the future. For instance, if IV is 30%, it indicates that the market expects the stock price to fluctuate within a 30% range during the specified period.)

Below are some specific ideas for options trading strategies:

1. If you hold a substantial position and are concerned about a potential market pullback after an interest rate cut, consider buying out-of-the-money Puts over the next couple of days to hedge against downside risk. This approach essentially involves paying a premium to acquire insurance against a potential decline. Recently,$SPDR S&P 500 ETF(SPY.US)$ and $Invesco QQQ Trust(QQQ.US)$ the volume ratio and open interest ratio of Put/Call have been rising, reflecting increased market bets or hedging activities against a potential downturn.

For strike prices, you may choose those approximately 3% below the current price (e.g., select a strike price around 641 when SPY is priced at 660.91), with expiration dates shortly after the Federal Open Market Committee meeting. The underlying assets can be your heavily-weighted stocks or broader market benchmarks such as SPY or QQQ.

If you wish to reduce the cost of this hedging strategy, while holding long positions in the underlying stock and buying Puts, you could also consider selling an out-of-the-money Call at a higher strike price. The income from selling the Call can help offset part of the cost of purchasing the Puts, aligning with the commonly used Long Collar options strategy. The trade-off is that if the stock price continues to rise, you will forgo profit potential above the Call’s strike price.

If you look left and think there will be a pullback after the rate cut, but look right and feel an unexpected event might occur, then you can consider betting on volatility by simultaneously purchasing the same number of Calls and Puts for the same underlying asset. As long as the volatility is sufficiently large, you can make a profit; however, if the volatility does not reach the expected level, this premium expenditure will result in a loss.

If the strike prices of the Put and Call are the same and close to the stock price, it forms a Long Straddle, also known as a straddle combination. If the strike prices of the Put and Call differ and both options are out-of-the-money (with the Put's strike price below the stock price and the Call's strike price above the stock price), it forms a Long Strangle, also referred to as a wide strangle combination.

In fact, last week in《Options Trading Insights | Key Options Strategies to Watch in September: Why SPY and QQQ Are Dominating?》this article, we discussed $Invesco QQQ Trust(QQQ.US)$ the Long Straddle case study involving QQQ. Currently, the price of QQQ is approaching the breakeven point of 593.66, soon entering the profit zone on the right side from the perspective of the expiration date. However, looking at the current option prices, the cost of this set of options had reached approximately $1,503 as of the opening of the U.S. market on September 16, which is higher than the original cost of $1,366.

If an unexpected event occurs in the short term, then after the outcome is announced, continuing to chase the rally by purchasing Calls may still offer some profit potential, though one must closely monitor market conditions and take timely profit or stop-loss measures.

At this point, the option’s Delta can guide the selection of strike prices. Delta reflects how the option price changes with fluctuations in the stock price. For example, when Delta is 0.5, it indicates that for every $1 increase in the stock price, the option price increases by $0.5. Choosing a Delta between 0.6 and 0.8 means the option is in-the-money, with its price reacting more noticeably to stock price changes, albeit at a higher purchase cost.

If you believe buying Calls could result in a total loss of premium, you can also consider reducing the cost of buying Calls by selling another Call at a higher strike price, forming a Bull Call Spread strategy. However, this approach sacrifices potential gains above the sold Call's strike price.

Finally, let’s briefly discuss the perspective of combining short-term and long-term strategies.

If we consider short-term market volatility trending downward but a longer-term upward trajectory, one could adopt a Short Put Calendar Spread by selling a put option with a later expiration while simultaneously buying a put option that expires sooner, with both having the same strike price and quantity.

This creates a hedge between the two options in the near term. If the market declines as anticipated, the near-term put can be closed for profit, while holding the longer-term put to benefit from potential price recovery, time decay, and premium collection.

Of course, this represents the most ideal scenario. The opposite may also occur, where the near-term put incurs losses and the longer-term put is exercised, requiring the holder to take delivery. However, at the outset of this strategy, there will be a net premium inflow that can help offset some potential losses.

Additionally, it may be prudent to consider implementing a hedging strategy across asset classes. On one side, establish positions in growth-oriented equities or adopt a LEAPS options strategy on SPY and QQQ (by purchasing longer-dated Call options). $SPDR Gold ETF(GLD.US)$ On the other side, allocate investments towards gold ETFs (e.g., ) or implement a LEAPS options strategy on other safe-haven assets.

Under current market conditions, these are essentially the main approaches. It is important to remind everyone that options are highly leveraged instruments, capable of producing substantial gains but also significant losses. Be sure to manage your positions carefully and set appropriate profit-taking and stop-loss levels. Moreover, given the dynamic nature of the current market, vigilance and timely adjustments are essential.

That concludes today's discussion. Regarding the backdrop of interest rate cuts, what strategies would you employ? Feel free to leave a comment and share your thoughts!

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