Wednesday, July 11, 2012

Pre-FOMC Drift

An interesting read from the New York Fed's Liberty Street Economics blog: "The Puzzling Pre-FOMC Announcement `Drift'".

The idea is that the market consistently rises the day before and also the day of a Federal Open Market Committee meeting announcement, with the rise the day of the announcement coming prior to the time the announcement is made.

The posting is based on a 48-page New York Fed staff report, "The Pre-FOMC Announcement Drift", which makes fascinating reading in its own right (as Fed staff papers always do). The paper was originally published in Sept. 2011 and revised last month.

I haven't yet done any back-testing on the S&P 500 index or its exchange-traded fund SPY, beyond a quick glance at the chart for the meeting dates this year, which seems to confirm the idea.

The way I would play it would be to buy a call option on SPY or the index itself near the end of trading two days before the announcement, hold it through the day prior to the announcement, and then sell an hour before the announcement time.

(I'm not saying that will play it. I'll want to look at the charts more carefully.)

Of course, now that the Fed study is again a topic of discussion, everyone will jump in to trade the drift, including people with high-capacity data links and algorithms, exaggerating its effects but also setting up a greater-fool stand-off: Who can beat the other players to the exits while still earnings a return? Who blinks first?

There are four announcements remaining this year: Aug. 1 at 2 p.m. Eastern, Sept. 13 at noon, Oct. 24 at 2 p.m., and Dec. 12 at noon.

Tim Bovee, Private Trader tracks the analysis and trades of a private trader for his own accounts. Nothing in this blog constitutes a recommendation to buy or sell stocks, options or any other financial instrument. The only purpose of this blog is to provide education and entertainment.
No trader is ever 100 percent successful in his or her trades. Trading in the stock and option markets is risky and uncertain. Each trader must make trading decision decisions for his or her own account, and take responsibility for the consequences.

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